202-T&C-5(2) - Econ 202 Terms and Concepts 5 AGGREGATE...

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Econ 202: Terms and Concepts 5: AGGREGATE DEMAND and SUPPLY Our graph of aggregate demand and aggregate supply looks like a traditional micro graph of prices and quantities, but now the quantity is output for the whole economy, GDP, and the price level is the General Price Level which has to be measured as a Price Index. 0 Price Level , P Output, GDP Aggregate Supply is upsloping with respect to the general price level, and Aggregate Demand is downsloping with respect to the general price level. The intersection between them determines the equilibrium level of GDP and the price level. 0 Price Level , P Output, GDP Aggregate Supply Aggregate Demand GDP e P e Recall that in microeconomics, the supply curve of an individual firm was the marginal cost curve, and that this curve became perfectly inelastic (vertical) at some level of output representing the most output that firm could produce given the scale of operation (physical capital) established. We assume that there is a similar limit to output imposed on the national economy by full employment and full capacity utilization, less any frictional and structural unemployment that represent upward mobility and changes in demand due to technological advance. We call that limit Potential GDP . 1
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0 Price Level , P Output, GDP Aggregate Supply Potential GDP Over the course of the business cycle, the aggregate demand curve shifts back and forth, calling for low levels of output during recessions and higher level of output during upturns, moving the economy closer to, or farther away from, it’s Potential GDP. 0 Price Level , P Output, GDP Aggregate Demand: Trough Aggregate Demand: Peak The difference between Potential GDP and the GDP that an economy achieves during a recession is called the Recessionary Gap , or, sometimes, the GDP gap. The goal of counter-cyclical fiscal policy is to shift the aggregate demand curve outward (rightward) so that equilibrium GDP comes closer to Potential GDP. Notice in the graph below that it is not the aggregate supply curve that shifts when Investment changes over the course of the cycle. In our understanding of the macro economy, investment in physical capital goods is part of aggregate demand. 2
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0 Price Level , P Output, GDP Aggregate Demand: Trough Aggregate Demand: Peak Potential GDP GDP e Recessionary Gap Before considering the implications of moving the aggregate demand curve and changing the general price level, let’s look at three kinds of shifts in aggregate demand and supply: changes in wealth, changes in taxation, and changes in technology. Wealth is the accumulation of previous savings. This is where the stock and bond markets enter the picture because they represent financial instruments that allow us to store our previous surpluses for many time periods before consuming them. This is the great advantage of money and other financial instruments that they do not rot or rust or otherwise deteriorate (getting worst) over time. When wealth increases the aggregate demand curve shifts to the right, raising the equilibrium level of GDP and also the general price level. The main source of wealth for the middle
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  • Summer '12
  • Kreider
  • Inflation, price level

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