im25 - Chapter 25 Aggregate Demand and Aggregate Supply...

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Chapter 25 Aggregate Demand and Aggregate Supply Overview This chapter focuses on the derivation of the aggregate demand and supply curves and on the determination of equilibrium output and the equilibrium price level in the short and long runs. The following informal derivation of the aggregate demand curve is presented: an increase in the price level reduces real money balances and raises the real interest rate; at a higher real interest rate, desired consumption and investment spending fall and, because a higher real interest rate increases the attractiveness of domestic financial assets relative to foreign financial assets and therefore raises the exchange rate, net exports also decline. The treatment of short-run aggregate supply is much more complete than that usually found in money and banking texts. The discussion focuses on the two most important approaches to short-run aggregate supply in the macroeconomic literature: the new classical, or misperceptions, theory, which holds that aggregate output differs from its full employment level only if the actual price level is different from the expected price level; and the new Keynesian approach, which holds that overlapping, multiyear nominal wage and price contracts and monopolistically competitive price setting result in price stickiness. Both the differences between the two approaches and the similarities are stressed. Discussing the similarities between the models is important because students often receive the impression that the differences among macroeconomists are greater than they actually are. Short-run and long-run equilibrium are discussed. The point is made that economists agree that short-run deviations from full employment output are eliminated in the long run by shifts in the short-run aggregate supply curve, although they disagree about the speed with which these shifts occur. The assumption of the real business cycle model that the aggregate supply curve is vertical even in the short run is set out and briefly discussed. Evidence that contradicts the real business cycle view indicating that output is affected in the short run by fluctuations in aggregate demand is alluded to (this evidence is discussed more fully in Chapter 26). Finally, aggregate demand and supply analysis are used to examine three historical episodes: (1) the fiscal and monetary stimulus of 1964–1969; (2) the supply shocks of 1973–1975 and 1995–2005; and (3) the decline in consumer and business confidence in 1990–1991. The 1990–1991 application can be used to study a “credit crunch” by those instructors who wish to skip Chapter 26 and move directly to Chapter 27. Outline I. The Aggregate Demand Curve A) Aggregate demand for the economy’s output equals the sum of demands for: 1. goods and services for consumption, C ; 2. investment in business plant and equipment, inventories, and housing, I ; 3. government purchases of goods and services, G ; and 4. net exports, NX .
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146 Hubbard • Money, the Financial System, and the Economy,
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This note was uploaded on 09/11/2011 for the course ECON 304 taught by Professor Sanchez during the Fall '11 term at NMSU.

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im25 - Chapter 25 Aggregate Demand and Aggregate Supply...

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