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Chapter 9 - Chapter 9 AD/AS MODEL In Ch 8 we focused on...

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Chapter 9 - AD/AS MODEL In Ch 8, we focused on static, equilibrium conditions in the AD/AS model. We now look at dynamic changes in the macro model - e.g. acts of nature like droughts or earthquakes, important discoveries like the computer chip, shifts in consumer confidence, political disruptions, etc. We will still assume that fiscal and monetary policy are unchanged so that we can see how private markets react to dynamic change. Then we can later look at the potential and limitations of macro policy. We distinguish between Anticipated and Unanticipated changes because dynamic adjustment differs depending on whether changes are expected or not. An anticipated change allows people time to adjust. Example : inflation is 5% now and government announces that inflation will be 10% next year or that inflation will be 0% next year. That is different than inflation being 5% and unexpectedly going up to 10% or down to 0%. Or researchers develop a new high yield drought-resistant hybrid seed that increases grain production by 10% (anticipated) vs. unusually favorable weather conditions resulting in a 10% increase in output. (unanticipated) Unanticipated change is change that catches most people by surprise, so that decisions were already made that did not take the event into account. Much of the change is unexpected, at least by the majority of the people. That is where the role of the entrepreneur becomes important. "Economics is largely about how people respond to change and how markets adjust to change." FACTORS THAT SHIFT AD - AD curve isolates the impact of price level on the Qd of Goods/Services (Real GDP). Factors besides price level changes also affect Real Output and those factors SHIFT the entire AD curve. Six factors: 1. Changes in Real Wealth - Changes in the price level affect real wealth by changing the real value of cash balances. Real wealth can also be affected by other factors. Example: Stock prices tripled between 92-98 - this represents an increase in
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real wealth of households holding stocks, mutual funds, pension funds, IRAs, etc. The stock market crashed in 87, a decrease in real wealth. The market has gone up by about 35% in the last year, DJIA almost 10,000, real wealth has increased. AD shifts out when AD increases from increase in wealth. 2. Changes in Real Int Rate - Int rates affect decisions of households and businesses in terms of their willingness to borrow. New Car and a Car Loan are like complimentary goods, goods that are consumed jointly. Our houses and mortgages, furniture and credit card debt. If the cost of financing a car or house or furniture goes down, the cost of the joint purchase goes down, and the demand increases. Lower int rates make the cost of buying a car/house cheaper, AD is stimulated, output increases.
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