chaptertwentythree - Ch 23 Aggregate Supply and Aggregate...

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Ch. 23 Aggregate Supply and Aggregate Demand - Expanding real GDP brings a rising standard of living. Inflation brings a rising cost of living. Aggregate Supply - The aggregate supply-aggregate demand model enables us to understand three features of macroeconomic performance: o Growth of potential GDP o Inflation o Business cycle fluctuations - Aggregate Supply Fundamentals o The quantity of real GDP supplied (Y) depends on 1. The quantity of labor (L) 2. The quantity of capital (K) 3. The state of technology (T) o Aggregate production function: Y = F(L, K, T) o The larger is L, K, or T, the greater is Y. o At any given time, the quantity of capital and the state of technology are fixed. They depend on decisions that were made in the past. The population is also fixed. But the quantity of labor is not fixed. It depends on decisions made by people and firms about the supply of and demand for labor. o The labor market can be in any of three states: at full employment, above full employment, or below full employment. o Even at full employment, there are always some people looking for jobs and some firms looking for people to hire, because there is a constant churning of the labor market. This prevents unemployment from ever disappearing. o Natural rate of unemployment : the unemployment rate at full employment o Another way to think about full employment: the state of the labor market in which the quantity of labor demanded equals the quantity supplied. Firms demand labor only when profitable: the lower the wage rate (cost of labor), the greater the quantity of labor demanded. People supple labor only if most valuable use of time: the higher the wage rate (return to labor), the greater the quantity of labor supplied. The wage rate that makes the quantity of labor demanded equal to the quantity of labor supplied is the equilibrium wage rage. At this wage rate, there is full employment. o The quantity of real GDP at full employment is potential GDP , which depends on the full-employment quantity of labor, the quantity of capital, and state of technology. Over the business cycle, employment fluctuates around full employment and real GDP fluctuates around potential GDP. - Long-Run Aggregate Supply o Following events tat move real GDP way from potential GDP, forces operate to bring them back together and restore full employment.
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o Macroeconomic long run : a time frame that is sufficiently long for these forces to have done their work so that real GDP equals potential GDP and full employment prevails. o Long-run aggregate supply curve : the relationship between the quantity of real GDP supplied and the price level in the long run when real GDP equals potential GDP. This relationship is shown by a vertical line – as the price level changes, real GDP remains at potential GDP.
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