Chapter13 - Lecture Notes Part 3 Chapters 13-16 Chapter 13...

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Lecture Notes, Part 3, Chapters 13-16 (4/02/09) Chapter 13: Aggregate Demand and Aggregate Supply In Chapter 13 we will allow P and W to adjust to clear markets, as in the classical model. The Aggregate Demand Curve As we have seen in Chapter 12, equilibrium spending and output depend upon the price level. The connection: An increase in the price level will cause (i) a decrease in the real money supply; (ii) an increase in the interest rate; (iii) a decrease in aggregate expenditures for output; and (iv) a decrease in output. This establishes a relationship between the price level and equilibrium output, as graphed below.
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2 P 0 P AD Y 0 Y The curve looks like (and, as we will see, behaves like) a micro demand curve. However, it is not .
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3 NOTE : If 0 P and 0 Y are on the aggregate demand curve, then (1)firms produce what is demanded (supply equals demand), Y= d Y , and (2)the real money supply equals real money demand, P M = φ . Shifts in the AD curve The AD curve is drawn holding (1)the nominal money supply, (2) autonomous demand ( ) A , and (3)autonomous money demand ( ) fixed A change in any one of these will cause a shift in the AD curve. The Rule : Apart from a price change, any change that increases spending is an increase in Aggregate Demand, Δ AD >0. The curve shifts to the right. Apart from a price change, any change that decreases spending is a decrease in Aggregate Demand, Δ AD <0. The curve shifts to the left.
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4 Output and Prices in the Long-run In the long run Y= f Y . How does this happen? Recall that aggregate expenditures are d Y = A + bY-f(R) . In the long-run d Y = A + b f Y -f(R) = f Y . There is an interest rate that makes this happen. Call the interest rate f R . When R= f R then d Y = A + b f Y -f( f R ) = f Y . In the long-run R = f R and Y = f Y . Note: f R depends directly upon A . An increase in A will cause an increase in f R ; a decrease A , a decrease in f R . What assures that R = f R ? Answer: Change is the price level.
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5 Assume the economy starts at full employment and there is an increase in Aggregate Demand, caused by (1)An increase in the nominal money supply, Δ M >0, or (2)An increase in the autonomous (exogenous) demand for output, Δ A >0, or (3)A decrease in the autonomous demand for money, Δ φ <0.
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6 P new P old P AD f Y Y
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7 Initial response to the AD increase : The increase in demand at initially causes an increase in output and no change in P . Long-run response : The price level increases, causing (i)a decrease in the real supply of money; (ii)an increase in the interest rate; (iii)a decrease spending, a movement up the AD curve.
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8 Output and the Price Level Each firm will set its price as a markup over its unit costs of production. P=unit cost of production +%markup
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This note was uploaded on 12/09/2009 for the course ECON 2006 taught by Professor Rdcothren during the Spring '08 term at Virginia Tech.

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Chapter13 - Lecture Notes Part 3 Chapters 13-16 Chapter 13...

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