LECTURE7 - ECON 1002 Introductory Macroeconomics Week 7...

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1 1 Introductory Macroeconomics Week 7 Aggregate Demand Aggregate Supply The short Run Supply Curve The Long Run Supply Curve ECON 1002
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2 This week’s story Adding an AS curve to the aggregate demand model allows for an improved analysis of aggregate output and the sources of macroeconomic fluctuations Distinguishing between the behaviour of aggregate supply in the short run and in the long run provides further clues as to the sources of macroeconomic fluctuations For the neo-classical, the economy will self-adjust (return to a potential output level) in the long run. By contrast, the Neo-Keynesian argue that, as wages are sticky, there is a need for government intervention in order for the economy to return to a full-employment equilibrium level
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3 Limitations of the aggregate expenditure model and the simple Keynesian multiplier It is assumed that prices remain constant (in large part because it is assumed that supply will fully and immediately respond to demand). However, the multiplier will be reduced if we take into account the fact that supply might not fully respond to demand and the subsequent impact on prices.
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4 Deriving the aggregate demand curve from the AE line: introducing the role of the price level (inflation) As a result of increasing prices, consumption and net exports fall. Hence, the PAE line shifts downwards. When prices fall, or the rate of inflation decreases, consumption, net exports and investment increases. As a result, Planned Aggregate Expenditure shifts upwards (refer WEEK 4)
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5 The AD curve and the PAE line We can derive the aggregate demand curve from the aggregate expenditure line by: 1. Altering the price level in the aggregate expenditure model 2. Linking together the equilibrium levels of GDP that can be derived from each aggregate expenditure line. As a result, the aggregate demand curve (AD) shows for each price level an equilibrium level of GDP where demand equals output (or where PAE = Y)
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6 The AD curve and the PAE line
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7 Demand and prices: a negative relationship Demand and prices: Income effects : Subsitution effects Real balance effects Monetary policy effect AD curve slopes downwards: higher prices lead to less spending
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8 The Aggregate Demand curve P Price level (inflation = π ) Aggregate output = Y AD The slope of the AD curve implies that increasing inflation rate leads to lower aggregate expenditure and therefore to lower output
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9 Changes in one or more of the components of PAE and shifts in AD Any influences ( other than prices ) on one or more of the components of aggregate expenditures will result in a shift of the aggregate demand curve The size of the shift, at any given price level, will depend on: The size of the change in the component of aggregate expenditure The size of the simple Keynesian multiplier Expenditures by households, businesses, government and foreigners change all the time, causing instability in the economy
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This note was uploaded on 04/14/2010 for the course ECON 1002 taught by Professor Markmelatos during the Three '10 term at University of Sydney.

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LECTURE7 - ECON 1002 Introductory Macroeconomics Week 7...

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