the theory of aggregate demand and supply

this presentation explain about the aggregate demand and economic fluctuation

1. Chapter
Twenty-
Four:
Aggregate
Demand and
Economic
Fluctuations

2. The Business Cycle

3. Figure 24.1: U.S. Real GDP and Recessions
Source: BEA quarterly data 1985–2012, and NBER

4. Figure 24.2: U.S. Unemployment Rate and
Recessions

5. -15
-10
-5
0
5
10
15
Inflation Rate
(Percent Annual)
Figure 24.3: U.S. Inflation Rate and Recessions
Source: “Economic Report of the President” 1985–2005; rate is calculated as a three-month moving average of the CPI; NBER.

6. Year
Trough
Contraction Expansion
GDP
Y*
Peak
Peak
Figure 24.4: A Stylized Business Cycle

7. 1929 1933
(a)Real Standard and Poor’s Stock Index 100.0 45.7
(b) Unemployment rate (official) 3.2% 24.9%
(c) Price level (CPI) 100.0 75.4
(d) Real gross domestic product 865.2 billion 635.5 billion
(e) Real personal consumption
expenditures 661.4 billion 541.0 billion
(f) Real gross private domestic
investment 91.3 billion 17 billion
(g) Real private debt 88.9 billion 102.0 billion
(h) Bankruptcy cases 56,867 67,031
(i) Non-farm real estate foreclosures 134,900 252,400
(j) Food energy per capita per day
(calories)
3460 3280
Table 24.1: The Early Years of the Great
Depression in the United States
Sources:(a) from Historical Statistics of the United States,p. 1004, series X495.; (b)-(c) from Dornbusch, Fischer, & Startz (2001);( d)-(f) from
http://www.bea.doc.gov/bea/dn/nipaweb/TableView.asp#Mid; (g) from Historical Statistics of the United States,p. 989, series X399.; (h) from Bradley Hansen and Mary
Eschenbach Hansen, The Transformation of Bankruptcy in the United States(http://academic2.american.edu/~mhansen/transform.pdf); (i) from Historical Statistics of the
United States,p. 651, series N301; (j) from Ibid.,p. 328, series 851; (d) and (e) are inflation-corrected using (b)

8. Macroeconomic Modeling and
Aggregate Demand

9. Output
(Y )
Income
(Y )
Spending
(Aggregate Demand or AD )
Spending
stimulates firms
to produce
Production
generates
incomes
Incomes give
actors the ability
to spend
Figure 24.5: The Output-Income-Spending Flow of
an Economy in Equilibrium

10. Production
generates
income to
households
Saving (S )
leakage
Intended Investment ( I
I)
injection
firms decide
how much to
invest
households decide how
much to consume and
save
Output (Y )
Spending (AD )
Income (Y )
Consumption (C )
?
Sufficient to
sustain output at
a steady level
Figure 24.6: The Output-Income-Spending Flow
with Leakages and Injections

11. Quantity of funds
borrowed and lent
Interest rate
140
5%
Supply of
Loanable
Funds
Demand for
Loanable Funds
E
1
Figure 24.7: The Classical Model of the Market for
Loanable Funds

12. Quantity of funds
borrowed and lent
Interest rate
140
5%
Supply of
Loanable
Funds
Original
Demand
E
1
New Demand
60
3%
E
0
Figure 24.8: Adjustment to a Reduction in Intended
Investment in the Classical Model

13. leakage
injection
Production
generates
income
Spending
stimulates
firms to
produce
Saving (S )
Equilibrium in
the market for
loanable
funds
Intended Investment
(I
I) is equal to S
Output (Y* )
Consumption (C )
Income (Y* )
Spending sufficient
to sustain full
employment
AD = Y*
Figure 24.9: Macroeconomic Equilibrium at Full
Employment in the Classical Model

14. The Keynesian Model

15. (1)
Income
(Y)
(3)
The part of consumption that
depends on income, with mpc
= 0.8
=0.8 column(1)
(4)
Consumption
C = 20 + 0.8Y
= column(2)
+ column(3)
(5)
Saving
S = Y–C
= column(1)
–column(4)
0 20 0 20 -20
100 20 80 100 0
200 20 160 180 20
300 20 240 260 40
400 20 320 340 60
500 20 400 420 80
600 20 480 500 100
700 20 560 580 120
800 20 640 660 140
Table 24.2: The Consumption Schedule (and
Saving)

16. 45
Consumption (C )
(= + mpc Y)
Income (Y )
Consumption
(
C
)
Consumption =
Income Line
400
Saving (S)
100C
500
400
300
200
100
0
= 20
340C
Slope = mpc
Figure 24.10: The Keynesian Consumption
Function

17. Income (Y )
Intended Investment
(= I
I
)
Intended
Investment (I
I)
(= I
I)
I
I= 60
Figure 24.11: The Keynesian Investment Function

18. Consumption (C )
Income (Y )
Consumption, Investment, and
Aggregate Demand
400
400
Aggregate Demand
(AD ) = C + I
I
Intended Investment (I
I)
340
80C +I
I=
Figure 24.12: Aggregate Demand

19. Table 24.3: Deriving Aggregate Demand from the
Consumption Function and Investment
(1)
Income
(Y)
(2)
Consumption
(C)
(3)
Intended
Investment
(II)
(4)
Aggregate Demand
AD = C + II
= column (2) + column (3)
0 20 60 80
300 260 60 320
400 340 60 400
500 420 60 480
600 500 60 560
700 580 60 640
800 660 60 720

20. Table 24.4: Aggregate Demand with Higher
Intended Investment
(1)
Income
(Y)
(2)
Consumption
(C)
(3)
Intended Investment
(II)
(4)
Aggregate Demand
(AD)
0 20 140 160
300 260 140 400
400 340 140 480
500 420 140 560
600 500 140 640
700 580 140 720
800 660 140 800

21. Income (Y )
Aggregate Demand
400100
1000
800
700
600
500
400
300
200
100
0
AD(I
I= 140)
800
AD(I
I= 60)
480
160
80
Figure 24.13: Aggregate Demand with a Higher
Level of Intended InvestmentIIC IIC
=
=

22. (1)
Income
(Y)
(2)
Aggregate
Demand
(AD)
(3)
Excess Inventory
Accumulation (+) or
Depletion (-)
= column(1)-
column(2)
(4)
Intended
Investment
(I
I)
(5)
Investment
(I)
= column(3)
+ column(4)
(6)
Check that the
macroeconomic
identity still holds:
Y = C+I
300 320 -20 60 40 300
400 400 0 60 60 400
500 480 20 60 80 500
600 560 40 60 100 600
700 640 60 60 120 700
800 720 80 60 140 800
Table 24.5: The Possibility of Excess Inventory
Accumulation or Depletion

23. 45
Income (Y )
Aggregate Demand and Output
Output = Income
Line
400100
1000
800
700
600
500
400
300
200
100
0
Aggregate Demand (AD )
800
E
unintended
investment
(build up of
inventories)
80
720
Figure 24.14: Unintended Investment in the
Keynesian Model

24. 45
Income (Y )
Aggregate Demand and Output
400100
1000
800
700
600
500
400
300
200
100
0
AD
0(I
I= 140)
800
E
0
Full Employment
Y*
160
Figure 24.15: Full Employment Equilibrium with
High Intended Investment

25. 45
Income (Y )
Aggregate Demand and Output
400100
1000
800
700
600
500
400
300
200
100
0
AD
0(I
I= 140)
800
E
1
E
0
Full Employment
AD
1(I
I= 60)
Persistent
unemployment
equilibrium
Y*
80
160
Figure 24.16: A Keynesian Unemployment
Equilibrium

26. Income (Y* )
Insufficient Spending
AD < Y*
Production
generates
income
Income goes
to households
If leakages
are larger
than
injections…
Lower Income
Lower Spending
AD = lower Y
Lower Output
Output (Y* )
Figure 24.17: Movement to an Unemployment
Equilibrium

27. (1)
Change in Intended Investment
(2)
Change in Aggregate Demand
(as C or I
Ichange)
and in Output and Income
(as firms respond to changes in AD)
(3)
Change in Consumption
ΔC = mpc ΔY
= .8 Column (2)
1. Investors lose confidence.
Δ I
I= 80
2. Reduced investment spending leads directly
to Δ AD= 80.
Producers respond to reduced demand for their
goods by cutting back on production.
Δ Y= 80
3. Less production means
less income. With income
reduced by 80, households
cut consumption
by mpc ΔY
= .8 80
ΔC = 64
4. Lowered consumption spending means
lowered AD
Δ AD= 64
Producers respond.
Δ Y= 64
5. Households cut
consumption
by mpc ΔY
= .8 4
ΔC = 51.2
6.Δ Y= 51.2
7.mpc ΔY=.8 51.2
ΔC =40.96
8.Δ Y= 40.96 9. ΔC = 32.77
10.Δ Y= 32.77 11. ΔC = 26.21
etc. etc.
Sum of changes in Y
= 80 + 64 + 51.2 + 40.96 + 32.77 +. . . .
= 400
Table 24.6: The Multiplier at Work