Ch.10 - CHAPER 10 AGGREGATE DEMAND AND AGGREGATE SUPPLY IN...

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Unformatted text preview: CHAPER 10 AGGREGATE DEMAND AND AGGREGATE SUPPLY IN THE SHORT-RUN: SUPPLY (Ignore Appendix at this time) (Ignore FALL, 2010 FALL, 1 INTRODUCTION 1. 1. In the Keynesian model, the In economy could exhibit either inflation, or unemployment, but not both! not 2. 2. Both the unemployment rate and Both the inflation rate began to rise after 1973 after 3. These events required an These expanded model to that could deal expanded with the problems of unemployment and inflation occurring at the same time. 2 A Recessionary Gap Recessionary P. 231 Figure 19.4 (Macro 9.4) An Inflationary Gap An P. 234 Figure 19.5 (Macro 9.5) THE AGGREGATE DEMAND THE SCHEDULE SCHEDULE Relates real aggregate Relates expenditures to the domestic price level, all other things equal level Vertical axis is a price index Horizontal axis is real GDP Horizontal Why does the aggregate demand schedule slope downward? (see Exhibit 1, P. 243) Exhibit Wealth (real balances) effect Wealth Interest rate effect Net exports effect Net 5 THE AGGREGATE DEMAND SCHEDULE, P. 243 SCHEDULE, Instructor’ s Note: A decline in the price level causes an increase in the quantity of real GDP demanded by C + I + G+X–M Figure 20.1 (Macro 10.1) THE WEALTH (REAL THE BALANCES) EFFECT BALANCES) The value of many financial assets The changes as the price level changes changes 1. 2. 2. 3. Value of checking accounts Value of savings accounts Value of certificates of deposit If the price level falls, the real If purchasing power of these financial assets increases. financial If the price level rises, the real If purchasing power of these financial assets declines. 7 THE INTEREST RATE EFFECT THE (1) (1) If the price level is stable: 1. 1. Nominal and real interest Nominal rates are the same. 2. 2. Banks that loan money at Banks 6% expect to receive $1.06 back at the end of the year for each dollar loaned. 3. If the price level rises, then the “real” interest rate is less than 6% less 4. As a result, during inflation 4. nominal interest rates rise, 8 and investment expenditures decline. FOREIGN TRADE EFFECT (3) If the domestic price level rises: If rises: 1. 1. 2. 2. 3. 3. U.S. exports fall U.S. U.S. imports rise U.S. X – M declines declines If the domestic price level falls: If 1. 2. 3. U.S. exports rise U.S. imports decline X- M increases 9 THE AGGREGATE DEMAND SCHEDULE, P. 243 SCHEDULE, Instructor’ s Note: A decline in the price level causes an increase in the quantity of real GDP demanded by C + I + G+X–M Figure 20.1 (Macro 10.1) SHIFTS IN THE AGGREGATE SHIFTS DEMAND SCHEDULE DEMAND The AD schedule (that is, the C + I + The G + X – M schedule) is shifted by factors other than changes in the other domestic price level. Examples include: include: 1. Changes in housing prices or 1. stock portfolio values portfolio 2. Changes in government 2. purchases (e.g., terrorism and war) 11 A SHIFT IN THE AGGREGATE SHIFT DEMAND SCHEDULE, P. 246 DEMAND Note: AD schedule shifts by Note: change in AE * multiplier change Figure 20.2 (Macro 10.2) THE AGGREGATE SUPPLY THE SCHEDULE SCHEDULE Relates real GDP supplied to Relates the overall price level the Price level on the vertical axis Real GDP on the horizontal Real axis axis Reflects profit maximizing Reflects behavior of business firms behavior 13 Alternative Views of the Alternative Aggregate Supply Schedule Aggregate Shape of aggregate supply Shape schedule is a matter of much disagreement: disagreement: Classical view Classical Keynesian view Keynesian “Modern” view Modern” “Short-run” vs. “long-run” Short-run” AS schedule taken up in Appendix to Ch. 10 that we will cover with Ch. 17 will 14 THE CLASSICAL AGGREGATE THE SUPPLY SCHEDULE SUPPLY Classical theory concluded Classical that the economy could be in equilibrium only at the full employment level of production. production. As a result, the Classical AS As schedule must be vertical schedule No matter what the level of No aggregate demand (AD) wage and prices would adjust so that the economy would be in equilibrium only at the full employment GDP. 15 employment THE CLASSICAL (VERTICAL) AGGREGATE SUPPLY SCHEDULE, Exhibit 4, p. 248 SCHEDULE, Figure 20.4 (Macro 10.4) KEYNESIAN AGGREGATE KEYNESIAN SUPPLY SCHEDULE (Exhibit 4, p. 238) p. The economy could experience either The unemployment, or inflation, but not both. Hence, the Keynesian AS schedule Hence, must be “L-Shaped: Horizontal until the full Horizontal employment GDP employment Vertical thereafter. A decline in AD leads to lower decline GDP, not falling wages and 17 prices ) GRAPH OF KEYNESIAN AGGREGATE SUPPLY SCHEDULE (see also Exhibit 4, p. 238) (see Price Level Vertical at full employme nt real GDP AS Horizontal until full employment Full Employment Point Real GDP 500 18 MODERN VIEW OF MODERN AGGREGATE SUPPLY SCHEDULE SCHEDULE Real GDP supplied will increase as Real the price level increases: A. Profit effect B. Cost effect Aggregate Supply Schedule Price Level Real GDP 19 THE AGGREGATE DEMAND AND AGGREGATE SUPPLY MODEL, Exhibit 6, p. 251 MODEL, Figure 20.6 (Macro 10.6) THE AGGREGATE DEMAND AND AGGREGATE SUPPLY MODEL, Exhibit 8, p. 254 MODEL, Figure 20.6 (Macro 10.6) CHANGES IN AGGREGATE CHANGES SUPPLY SUPPLY What factors cause AS to What shift? Increased worker Increased productivity. Technological change Increased training and Increased education of work force education Deregulation Increased competition. Oil prices Factors that influence Factors production costs shift the AS 22 schedule schedule IMPACT OF HIGHER ENERGY IMPACT COSTS Price Level AS2 AS1 AD1 Real GDP 23 GRAPH OF SUPPLY-SIDE GRAPH ECONOMICS ECONOMICS Price Level AS1 AS2 AD1 Real GDP 24 AGGREGATE DEMAND AND AGGREGATE SUPPLY POLICIES: Exhibit 12, p. 261 p. AS1 Price Level AS2 AD2 AD1 Real GDP 25 THE BUSINESS CYCLE Caused by shifting AD and AS Caused schedules Changes in the unemployment Changes rate rate Changes in the inflation rate Demand-pull inflation Cost-push inflation Changes in both unemployment Changes and inflation rates Keynes emphasized changes in AD Keynes No problem in Keynesian range of No AS schedule AS 26 Tradeoffs in the intermediate Tradeoffs AGGREGATE DEMAND VS. AGGREGATE AGGREGATE SUPPLY POLICIES AGGREGATE Keynesian policies emphasized AD New “supply-side” policies New advocated during 1980’s advocated Would reduce both inflation rate and unemployment rate Shape of AS schedule less Shape important as long as AD schedule is downward sloping See Exhibit 12, P. 246 27 APPENDIX TO CHAPTER 10: Short-run vs. Long-run AS Short-run Schedules Schedules Hold for Chapter 17 Hold Do not cover as part of Chapter 10 Do 28 END CHAPER 10 END LECTURE LECTURE QUESTIONS????????? 29 ...
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