Case Study: Policy in the Great Depression
The economy during the Great Depression faced a 25% unemployment
rate, multiple bank failures, and emotional distress.
An unequal distribution of wealth, inflated stock prices, and insolvent banks
led to the Grea
Shifts in Aggregate Demand
The aggregate demand (AD) curve slopes downward because output
decreases as the price level increases.
Increases or decreases in autonomous spending components can shift the
AD curve. Through policy changes, the government can a
Movement Along the Aggregate Demand Curve
Review: Y = C + I + G + NX. Spending equals income.
Rising prices decrease spending and real GDP.
The microeconomic demand curve measures the substitution effect and
the income effect.
The macroeconomic ag
Deriving the Aggregate Demand Curve
Recall that the circular flow model illustrates the real flow of goods and
services, holding prices constant.
The aggregate demand curve illustrates aggregate expenditures as a
function of the price level.
Changes in Taxes
In Keyness macroeconomic equilibrium, leakages out of the circular flow
model must equal injections into the model.
Taxes are a leakage out of the circular flow model.
Government spending on goods and services compensates for the reductio
Changes in depreciation, technology, government policy and interest rates
influence investment expenditures.
The downward-sloping investment demand curve illustrates the inverse
relationship between the interest rate and investment.
The Expenditure Approach and the Saving Approach
Keyness demand-driven model illustrates that in a stable economy,
spending must equal income.
In an economy without savings, consumer spending equals income.
In an economy with savings, total invest
Changes in Aggregate Expenditures
The multiplier effect occurs when a small change in autonomous
spending causes a huge change in equilibrium output.
Keynes believed that expansionary fiscal policy could initiate a booming
economy and that contracti
Applications of the Multipliers
The multiplier effect occurs when a small increase in autonomous
spending (a, I, G, or NX) results in a larger increase in real GDP, or
You can derive the multiplier using either a geometric sequen
Changes in Net Exports
We can define macroeconomic equilibrium in two ways: spending = income,
or leakages = injections.
Foreign demand is an injection into the circular flow model and is
determined by preferences, income, trade barriers, and the exchange
The Classical View
The classical model of economics describes how wages and prices adjust
immediately to clear markets.
The Keynesian perspective holds that prices and wages are sticky in the
short run and therefore slow to adjust.
When the wage r
Expectations and the Phillips Curve
Shifting the aggregate demand (AD) curve outward causes prices and
output to increase and unemployment to decrease.
Moving along the short-run aggregate supply (SRAS) curve illustrates
the inverse relationship between u
Definitions and the Historical Record
The Phillips curve illustrates the inverse relationship between inflation
The Phillips curve will shift outward as people adjust to higher inflation and
remains stable only at a natural rate of unemp
Case Study: The U.S. National Debt
The U.S. national debt is the sum of outstanding Treasury securities
issued by the government largely to its own citizens in order to finance
To understand the significance of debt, it should be computed as a f
Expectations in the Long Run and the Short Run
During periods under full employment, prices adjust downwards.
During periods above full employment, prices adjust upwards.
Price pressure ends at full employment, but the adjustment time depends
Long-Run Macroeconomic Equilibrium
When the aggregate demand (AD) curve shifts outward, prices and
output increase in the short run. The long-run equilibrium is established at
a higher price level, and output returns to full employment.
When the sho
Equilibrium in the Long Run and the Short Run
Recall that sticky wages, sticky prices, and confusion create profit
opportunities and an upward-sloping short-run aggregate supply
When the price level is less than equilibrium, excess short-run
The Labor Market
The long run is a period of time long enough for prices of both inputs and
outputs to adjust. During this period of time, businesses cannot profit from
The short run is a period of time in which some prices adjust, but ot
The Long-Run Aggregate Supply Curve
In the long run, all prices have completed their adjustments. There is no
relationship between the price level and output.
The long-run aggregate supply curve (LRAS) is vertical at the full
employment output level.
The Aggregate Expenditure Identity
Aggregate expenditures (AE) is the sum of all individual sectors in the
Keyness equilibrium dictates that all spending must be planned spending to
prevent unintended inventory accumulation.
The linear consu
Average and Marginal Propensities to Consume and Save
Aggregate expenditures are the sum of spending plans of households
(C), businesses (I), government (G), and foreigners (NX).
Assuming taxes equal zero, total consumer income is either spent or saved.
Says Law and Keynes: An Overview
The classical view: Prices, output, and the money supply are related in
macroeconomics. The macroeconomy works like independent markets as
supply and demand adjust to establish equilibrium.
Says Law: Supply creates demand.
Theoretical Explanations for Cycles
Many theories explain the causes for economic fluctuations illustrated by
the business cycle.
These differing theories appear in almost all economic discussions and are
used to make predictions about the future directio
Recessions, Depressions, and Booms
The business cycle describes fluctuations of economic activities over a
period of time.
An expansion is a period when real GDP is rising more rapidly than the
trend. Significant or prolonged expansions are called booms.
Calculating the Rate of Inflation
The consumer price index (CPI) measures the change in prices of
yesterdays goods and services relative to todays dollar by holding
The GDP deflator measures the purchasing power of yesterdays do
Changes in the Cost of Living and the CPI
Inflation is a general increase in the price level across an economy.
The consumer price index (CPI) seeks to measure inflation by
calculating the prices of typical household expenditures.
The producer price index
The income approach to calculating GDP considers all the income created
when buyers purchase goods and services.
Adjust national income to find the total income received in the economy.
Because spending must equal income in the macroeconom
The expenditures approach to calculating GDP considers each
component of total spending in an economy over a given period of time.
Consumer spending (C), investment spending (I), government spending
(G), and net exports (NX) sum to c
Limitations of GDP and Alternative Indexes
GDP, or Gross Domestic Product, may not be a good measure of the
standard of living across countries or over time
GDP measurements leave out several factors that affect wellbeing
Alternative indexes such as the H
Gross domestic product (GDP) is the market value of all final goods and
services produced within a country in a given period of time, regardless of
the nationalities or permanent residencies of the producers.
Gross national product (GNP) is the m