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Lecture week 9

# Lecture week 9 - ECON1102 MACROECONOMICS LECTURE GROUP C...

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ECON1102 MACROECONOMICS LECTURE GROUP C WEEK 9 AGGREGATE DEMAND AND AGGREGATE SUPPLY TEXT REFERENCE Ch 11 OUTLINE: 1. THE AGGREGATE DEMAND (AD) CURVE 2. INFLATION AND AGGREGATE SUPPLY (AS) 3. USING THE AS-AD MODEL

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THE AS – AD MODEL 1. THE AGGREGATE DEMAND (AD) CURVE In the previous Lecture we developed the following two models: A PAE curve that depended on the real interest rate A policy reaction function for the RBA, in which the real interest rate responded to the inflation rate These two equations can be combined to produce a relationship between output and inflation: “The Aggregate Demand Curve” PLANNED AGGREGATE EXPENDITURE r T Y c C C ) ( r I I P G G X N NX T T NX G I C PAE P Substituting: cY r X N G I T c C PAE ] ) ( [ Assuming output ( Y) adjusts to meet PAE , we can use the equilibrium condition: Y = PAE to solve for equilibrium output: cY r X N G I T c C Y ] ) ( [ ] ) ( [ 1 1 r X N G I T c C c Y
RBA POLICY REACTION FUNCTION We assumed that the policy reaction function of the RBA can be represented by the following equation: g r r r and g are positive constants chosen by the RBA g indicates by how many percentage points the RBA raises the real interest rate in response to a given rise in inflation r indicates the value of the real interest rate when inflation is zero. A change in

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