KW_Macro_Ch_11_Sec_03_Behind_Shifts_of_the_AD_curve_The_Income-Expenditure_Model

KW_Macro_Ch_11_Sec_03_Behind_Shifts_of_the_AD_curve_The_Income-Expenditure_Model

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>> Income and Expenditure Section 3: Behind Shifts of the Aggregate Demand Curve: The Income-Expenditure Model chapter 11 After 9/11, American politicians voiced concern about a possible slump in consumer spending. We can understand that concern in terms of the analysis of short-run eco- nomic fluctuations we developed in Chapter 10. There we learned that most, though not all, recessions are caused by negative demand shocks —leftward shifts of the aggre- gate demand curve. What people feared after 9/11, then, was another negative demand shock. We also learned in Chapter 10 how to use the multiplier to answer the question of how much the aggregate demand curve shifts in response to a demand shock. We saw that due to the multistage process of a change in aggregate demand leading to changes in real GDP, disposable income, and consumer spending, the magnitude of the shift of the aggregate demand curve is several multiples of the size of the original demand shock. In this section, we will examine this multistage process more closely. We’ll see
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2 CHAPTER 11 SECTION 3: BEHIND SHIFTS OF THE AGGREGATE DEMAND CURVE that the multiple rounds of changes in real GDP are accomplished through changes in the amount of output produced by firms—changes that they make in response to changes in their inventories. And we’ll come to understand why inventories play a cen- tral role in macroeconomic models of the economy in the short run, and why econo- mists pay particular attention to the behavior of firms’ inventories when trying to understand the likely future state of the economy. Before we begin, let’s quickly recap the assumptions underlying the multiplier process. 1. The aggregate price level is fixed . In other words, we’ll analyze the determination of aggregate output as if the short-run aggregate supply curve, SRAS, is horizontal at a given aggregate price level. This is in contrast to the upward-sloping short-run aggregate supply curve of the AS–AD model. A fixed aggregate price level also implies that there is no difference between nominal GDP and real GDP. As a result, we can use the two terms interchangeably in this chapter. 2. The interest rate is fixed. We’ll take the interest rate as predetermined and unaf- fected by the factors we analyze in the model. As in the case of the aggregate price level, what we’re really doing here is leaving the determinants of the interest rate outside the model. As we’ll see, the model can still be used to study the effects of a change in the interest rate. 3. Taxes, government transfers, and government purchases are all zero. 4. There is no foreign trade . The Chapter 12 Appendix addresses how taxes affect the multiplier process. In all subsequent chapters we will drop the assumption that the aggregate price level is fixed. We’ll explain how the interest rate is determined in Chapter 14 and bring for- eign trade back into the picture in Chapter 18.
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Planned Aggregate Spending and Real GDP
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KW_Macro_Ch_11_Sec_03_Behind_Shifts_of_the_AD_curve_The_Income-Expenditure_Model

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