Therefore, have to lower output. This is called a recessionary gap. This may lead to the paradox of thrift, households increase saving and decrease spending which may prolong the recession. When the 45-degree line is lower than AE the economy wants more goods/services. Firms need to produce more output. This is called expansionary gap. Increases in aggerate expenditureAnything that causes C, I, G, NX to increase causes the AE function to shift up.Multiplier effect: (1/1-MPC)Works with both increases and decreases in autonomous expendituresIncreases in MPC leads to increases in the multiplierIgnores interest rates, imports, wealth. Chapter 13 – Aggerate demand and aggregate supply analysisWhy does aggregate demand curve have a negative slope?The wealth effect (price level)Interest rate effect International trade effectAD shifts right if Monetary policy decreases interest rates. This is called expansionary monetary policy. AD shifts right if Fiscal policy decreases Taxes. This is called expansionary fiscal policy.AD shifts left if the monetary policy increases interest rate. This is called contractionary monetary policy.AD shifts left if the fiscal policy increases taxes. This is called contractionary fiscal policy. AD shifts right if there is increase in consumer confidence or expected future income and increase in firm confidence or expected future profits increase. AD shifts left if the U.S. GDP increases relative to abroad. There is an increase in the value of the U.S. dollar. Aggregate supply Long run aggerate supply (LRAS): vertical, prices have time to adjust fully. GDP is determined by the factors of production. The economy is at full employment/potential GDP. In the Keynesian model, Wages are sticky so price level doesn’t really do down as were in really bad unemployment but as we get closer to full employment that means wages start going up doesn’t matter if were producing more. The quantity at some point is completely set because we can’t produce beyond some point. Short-run aggregate supply:changes in the price level causes a movement along the SRAS curve, not a shift. The SRAS shift right if there is an increase in capital stock or labor force. Positive technological change. Increase in productivity. Decrease in the expected future price level. Workers and firms underestimate the increase in the price level and adjust wages by a lower amount. A sudden decrease in the price of an important output including natural resource, this is referred to as positive supply shock. When AD=SRAS=LRAS we have long run macroeconomic equilibrium. When AD shifts left, we have a recessionary gap.Decrease in wages leads to decrease in expected prices which lead to SRAS shifting to the right. When AD shifts right, we have an expansionary gap.Increasing wages and increasing expected prices. SRAS shifts left. When SRAS shifts left, we have a recessionary gap. When there is increase in unemployment and increase inflation rate we have “stagflation”When SRAS shifts right we have an expansionary gap.
LRAS shifts right over time as potential GDP increasesAD is usually shifting right over time with increase in incomes and populationSRAS is usually shifting right overtime with increases in the factors of production and productivity.