Aggregate Demand and Aggregate Supply... Equilibrium output Quantity of Output Price Level 0 Equilibrium price level Aggregate supply Aggregate demand
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Spending Output Income Spending Aggregate Demand and Aggregate Supply Y = C + I + G + NX Why AD slopes downward Why AD might shift Why Short-run AS (SRAS) slopes upward Vertical LRAS Why AS might shift—Recall: CostsSupply “Long-run” (Medium run) AS-AD Equilibrium Expectations Augmented Phillips Curve Okun’s Law Money Supply—Money multiplier Money Demand—Money market equilibrium Response to monetary expansion Response to fiscal expansion Spending multiplier/Crowding out Automatic stabilizers Rules vs. discretion GROWTH
Transcript
Spending Output Income SpendingAggregate Demand and Aggregate Supply
Y = C + I + G + NXWhy AD slopes downwardWhy AD might shiftWhy Short-run AS (SRAS) slopes upwardVertical LRASWhy AS might shift—Recall: CostsSupply“Long-run” (Medium run) AS-AD EquilibriumExpectations Augmented Phillips CurveOkun’s LawMoney Supply—Money multiplierMoney Demand—Money market equilibriumResponse to monetary expansionResponse to fiscal expansionSpending multiplier/Crowding outAutomatic stabilizersRules vs. discretionGROWTH
$GDP: The market value of all final goods and services produced in our economy in a year
GDP Deflator (=P): The dollar value of a year’s outputs relative to what it would have been had prices remained constant at base year prices.
• In practice, the increase in a year’s prices over the prior year’s (for all the things produced this year – C,I,G, and X) chained to the base year.
Real GDP (= Y): $GDP measured at base year pricesReal GDP = $GDP/Price Deflator
Y = $GDP/P
Spending Output Income Spending
Aggregate Demand and Aggregate Supply...
Equilibriumoutput
Quantity ofOutput
PriceLevel
0
Equilibriumprice level
Aggregatesupply
Aggregatedemand
The Aggregate Demand Curve
The four components of GDP (Y) contribute to the aggregate demand for goods and services.
Y = C + I + G + NX
The Aggregate-Demand Curve...
Quantity ofOutput
PriceLevel
0
Aggregatedemand
P1
Y1 Y2
P2
2. …increases the quantity of goods and services demanded.
1. A decrease in the price level...
Why the Aggregate Demand Curve Is Downward Sloping
Price Level and Consumption: Wealth Effect…the purchasing power of money balances
Price Level and Investment: Interest Rate Effect
Price Level and Net Exports: Substitution effect The Exchange-Rate Effect via real balances and
interest rate
Why the Aggregate Demand Curve Might Shift Shifts arising from Consumption
Changes in wealthHouse pricesStock prices
Shifts arising from Investment Responses to interest rate New technologies Animal Spirits
Shifts arising from Government Purchases Shifts arising from Net Exports
The Aggregate Supply Curve
In the long run, the aggregate-supply curve is vertical.
In the short run, the aggregate-supply curve is upward sloping.
The Short-Run Aggregate Supply Curve...
Quantity ofOutput
Price Leve
l
0
Short-runaggregate
supply
Y1
P1
Y2
2. reduces the quantity of goods and services supplied in the short run.
P2
1. A decrease in the price level
Why the Aggregate Supply Curve Slopes Upward in the Short Run
Sticky – wages Profit Up when Prices Up
High output Low Unemployment Wages Up Prices Up
The Long-Run Aggregate- Supply Curve...
Quantity ofOutput
Natural rateof output
Price Level
0
Long-runaggregate
supplyP1
P2 2. …does not affect the quantity of goods and services supplied in the long run.
1. A change in the price level…
Why the Aggregate Supply Curve Might Shift:Recall: Supply reflects costs
Shifts arising from Labor Higher wages higher costs given output can/will only be supplied at higher price
Shifts arising from Capital Increase in capacity increase in supply
Shifts arising from Natural Resources Increase in resource price increased costs
Shifts arising from Technology. Shifts arising from the Expected Price Level.
The Long-Run Equilibrium
Quantity ofOutput
PriceLevel
0
Short-run aggregatesupply
Long-runaggregate
supply
Aggregatedemand
AEquilibrium price
Natural rateof output
1. A decrease inaggregate demand…
AD2
A Contraction in Aggregate Demand...
Quantity ofOutput
PriceLevel
0
Short-run aggregatesupply, AS1
Long-runaggregate
supply
Aggregatedemand, AD1
AP1
Y1
BP2
Y2
2. …causes output to fall in the short run…
AS2
CP3
3. …but over time,the short-run aggregate-supply curve shifts…
4. …and output returnsto its natural rate.
Expectations Augmented Phillips Curve, 1949-2007
-6
-4
-2
0
2
4
6
8
10
0.0 2.0 4.0 6.0 8.0 10.0 12.0
Unemployment Rate
Okun's Law , 1949 - 2006
-3.0
-2.0
-1.0
0.0
1.0
2.0
3.0
4.0
-4.0 -2.0 0.0 2.0 4.0 6.0 8.0 10.0
Real GDP Growth (%)
Money SupplyMeans of Payment:
Currency + Demand Deposits= Money multiplier x Monetary Base
= Money multiplier x (Currency + Reserves)
The money supply is controlled by the Fed through: Open-market operations Changing reserve requirements Changing the discount rate
The public’s willingness to deposit money in banks and bank willingness to lend matter as well
Money Demand
The opportunity cost of holding money is the interest that could be earned on interest-earning assets—bonds
An increase in the interest rate raises the opportunity cost of holding money.
As a result, the quantity of money demanded is reduced
Changes in Government Purchases Macroeconomic effects from change in
government purchases: The multiplier effect The crowding-out effect
The Multiplier Effect...
Aggregate demand, AD1
Quantityof Output
0
PriceLevel
AD2 1. An increase in government purchases of $20 billion initially increases aggregate demand by $20 billion…
$20 billion
AD3
2. …but the multiplier effect can amplify the shift in aggregate demand.
Formula for the Simpler Spending Multiplier
Multiplier = 1/(1 - MPC) MPC is the marginal propensity to consume
It is the fraction of extra income that households consume rather than save.
The greater the MPC, the more total output (Y), income and spending results from an initial increase in spending
AD3
4. …which in turn partly offsets the initial increase in aggregate demand.
The Crowding-Out Effect...
Aggregate demand, AD1
(b) The Shift in Aggregate Demand
Quantity of Output0
Price
Level
(a) The Money Market
Quantity of
Money
Quantity fixed by the
Fed
0
r1
Money demand, MD1
Money supply
Interest Rate
1. When an increase in government purchases increases aggregate demand…
AD2
$20 billion
3. …which increases the equilibrium interest rate…
r2
MD2
2. …the increase in spending increases money demand…
Automatic Stabilizers
Automatic stabilizers are changes in fiscal policy that stimulate aggregate demand when the economy goes into a recession without policymakers having to take any deliberate action.
Automatic stabilizers include the tax system and some forms of government spending.
The Case for Active Stabilization PolicyThe Employment Act has two implications: The government should avoid being the cause
of economic fluctuations. The government should respond to changes in
the private economy in order to stabilize aggregate demand, e.g., the Bush tax rebate and Obama’s stimulus package Obama insisted that only government could
“break the vicious cycles that are crippling our economy,” prevent “the catastrophic failure of financial institutions,” restart the flow of credit and restore the regulations needed to prevent such a crisis in the future. January 8, 2009
The Case Against Active Stabilization Policy
Active monetary and fiscal policies may destabilize the economy.
Monetary and fiscal policies affect the economy with a substantial lag.
They suggest the economy should be left to deal with the short-run fluctuations on its own. Avoid monetary mischief
