Chapter 23 Class and Textbook Notes
The Aggregate Demand (AD) curve
·
the AD curve is a curve that shows the demand for all goods and services
(GDP) by all 4 sectors of the economy
·
the curve is drawn on a
graph that has the Price Level (P) on the vertical
a X is and Real GDP ly] on the horizontal axis
·
each point on the curve represents a planned amount of AE at
different Price Levels
·
The AD curve is downward sloping
this says as the Price Level goes up (inflation) planned At falls
,
The inverse relationship between P and Y
explained by the effect of a rising Pon consumption investment and
·
, ,
Net Exports
I the money of households
·
a rising means
holdings cannot purchase
as
many goods and services and consumption (2) will fall ,
WhenP rises more purchase will use borrowed dollars ,
Causing the
demand for credit to rise which leads to higher interest rates
· The increase in interest rates will cause business Inventories (1) to fall
Domestic Price Level Increase
·
as our domestic Price level increases relative to foreign price levels our
Exports will drop and our imports will increase
net exports /NX) will decrease
What a
rising Price Level (P) causes
a
rising P Causes C , 1 , and NX to decrease
·
We see this as a downward shift of the AE curve which brings about
a macroeconomic equilibrium at a lower level of GDP
we also see this as a movement up the AD curve to a point that
marries the higher price level to a lower GDP
The Aggregate Demand Curve GRAPH
·
The effect of a
change in the price level on Real GDP
At 450 Y = AE AE 450y = AE
Ahincrease So
in AE , AEz
Adecreasea
·
At z AE ,
Y
· Y
9
higher price level on Real GDP b Lower
.
price level on Real GDP
The Impact of the 3 expenditures
1) The Wealth Effect : as PH ,
Ch
·
The effect of the price level on consumption
As prices rise people feel less wealthy they spendless leading to
·
, ,
so ,
a
decrease in demand , which causes the AD curve to slope downwards
2) The Interest Rate Effect : as Pr It,
·
The effect of the Price level on investment and consumption
·
as prices rise people and
,
businesses need more money to buy goods and
Services , which increases the demand for loans
this drives up interest rates , making borrowing more expensive
Higher interest rates reduce and investment, which lowers over all
·
spending
demand and causes the curve to slope downward
3) The International-Trade Effect : as Pr ,
NXV
·
The effect of the price level on net exports
·
As the domestic price level rises goods and services become ,
more
expensive for foreign buyers ,
which reduces exports
at the same time , foreign goods become cheaper for domestic consumers ,
increasing imports
this reduction in net exports leads to a decrease in overall demand , which
is why the AE curve slopes downwards
The Price Level Changing is what causes us to move
along the AD curve to
·
a
different planned amount of AE
The Factors that cause the AD curve to shift
1) Changes in government policies
2) changes in expectations of households and firms
3) changes in foreign variables
anytime anything changes (other than the price level) that cause
any of the
4 sectors' expenditures to
change ,
AD will shift accordingly
P
Recrease
(increase
T
T AD ,
Apati
Y
Examples that would cause the AD Curve to shift
If we experience natural disaster to spend
a
prompting the government
·
billions of dollars in aid , Gy and ADV
emergency
·
If interest rates rise causing businesses to fund fewer investment projects, It
and AD +
·
If Consumer confidence improves , C+ and ADT
The Aggregate Demand and Aggregate Supply Model
·
AD + AS
Demand for
everything (GDP) by everybody lanyone who buys GDP)
·
·
Law of Demand does not apply here
P
B
124
---- g
121--- AB
The Aggregate Supply (AS)
·
We have 2 aggregate supply curves
1. Long Run Aggregate Supply Curve (CRAS)
. Short-Run
2
Aggregate Supply Curve /SRAS]
Long Run Aggregate Supply
because changes in the price level do not affect the number of workers ,
·
the Capital stock , or technology ,
in the long run :
changes in the price level do not affect the level of real GDP (this is
why it's vertical e line at the potential level of real GDP)
·
level of real GDP in the long run is called potential GDP ,
or full-employment
GDP
shows the relationship between the price level and the quantity of real GDP
supplied
·
always shows us where we want to be but it doesn't show us where we're
at
·
When we are at potential GDP , we are
experiencing the Natural Rate of
Unemployment and Cyclical Unemployment =
o
CRAS Curve (GRAPH)
As LRAS
Y
Y AE
Why the LRAS curve increases (shifts to the
right)
shifts to the as the productive
increases or
right each year capacity
·
of the economy increases
·
The productive capacity increases due to :
Increasing (workers and Capital goods(
·
resources
·
Increasing technology
LRAS Shift (GRAPH]
As LRAS LRAS'
>
-
Y
YAE >
- YAE'
The Short-Run Aggregate Supply Curve
·
over the short-run as the price level + the
, quantity of goods and services
firms are willing to supply will I
SRAS Curve /GRAPHY
P SRAS
-pation
i Y -
Y
Three reasons why the SRAS curve is upward sloping
1) contracts make some
wages and prices "Sticky"
this means prices or
wages are said to be "sticky" When they do
not respond quickly to changes in demand or supply
not respond quickly to changes in demand or supply
2) Firms are often slow to Wages
adjust
If firms are slow to adjust Wages ,
a rise in the price level will
increase the profitability of hiring more workers and producing more
output
a fall in the price level will decrease the profitability of hiring
more workers and producing more output
3) Menu costs make some prices
sticky
"menu costs" The : costs to firms of changing prices
firms face costsWhen
changing prices ,
so they may delay price
adjustments even if market conditions change
as some firms keep prices fixed during a price level increase leading,
to a higher relative demand and increased output from those firms
Variables that cause the SRAS curve to shift
1) changes in the Labor Force or Capital Stock
Resources
·
increase in the labor force /more workers available) which allows firms
to produce more goods and services >
- Shifts SRAS curve to the right
· increase in Capital stock (more machines , tools , factories ,
etc.) makes
workers more productive and boosts output >
-
Shifts SRAS curve to the right
·
decrease in labor force or
Capital Stock (ex : war , natural disaster ,
or aging
population) reduces production Capacity >
-
Shifts SRAS curve to the left
2) Technological Change
Positive
·
technological change >
-
Shifts SRAS curve to the right
·
Negative technological Change > -
Shifts SRAS curve to the left
3) Expected changes in the Future Price Level
·
If firms expect higher future prices : they increase production costs+
Shifts the SRAS curve to the left
·
If firms expect lower future prices: they reduce current costs >
-
shifts the
SRAS curve to the right
4) Adjustments to Errors in Past Expectations of the Price Level
·
If prices were
higher >
- firms raise Wages and costs >
- SRAS curve shifts to left
· Prices were lower
If >
- firms lower and costs SRAS Curve shifts to right
Wages -
5) unforeseen Change in the Price of a Vital Natural Resource
·
If resource prices rise unexpectedlye higher production costs >
- SRAS shifts left
· If resource prices fall unexpectedly -> lower production costs - SRAS shifts right
NOTE : When there is an increase in the Labor Force , Capital Stock and /or technology
, ,
BOTH the LRAS and SRAS curves will increase (shifts to the right
Macroeconomic Equilibrium -
how LRAS &SRAS interact
·
intersection of AD and SRAS curves
provides us with the Current Price Level and level of GDP
·
If the SRAS/AD intersection occurs on the LRAS -
Long-run macroeconomic
equilibrium
LRAS doesn't play a role in resulting the equilibrium
·
The SRAS/AD intersection Can occur below , on
,
or above the CRAS curve
P LRAS
SRAS
·
shows us where we're at and also where we
both)
------
want to be (we are
AD
Recessions
·
a result in AD decreasing causing the ,
Macroeconomic equilibrium to fall below
the LRAS curve and Potential GDP
as a result of increased unemployed resources, resource prices typically fall
·
·
the SRAS curve shifts to the right bringing a macroeconomic equilibrium at a
higher level of GDP
P LRAS
SRAS
SRAS z
F
1. A decline in
investment shifts
↓ E &
AD to the left
, .
2 As firms/workers adjust
causing a recession to the PL being lower than
↓ +meyexpected , costs will fall
AD andCause SRAs to shift right
ADz
S Y
.
3 Equilibrium from B
moves
back to potential GDP at C ,
with a lower Price Level
Expansion
·
from increasing our AD that takes our macroeconomic equilibrium above the LRAS and
Potential GDP
·
when this happens the Price Level increases causing resources to be higher priced
·
as a result , the SRAS curve Will shift to the left and equilibrium GDP will fall
P LRAS SRASz
SRAS
-e &
1. An increase in
=== ==
·
C
GB
- 2
. Asfirms/workers adjust to PL
investmentShiftan
-
↑ being higher than they expected,
"
------- A
costs will rise and cause SRAS to
inflationary expansion
Shift to the left
ADz
AD
- Y
.
3 Equilibrium moves from B
back to potential GDP at [ ,
with a higher price level
Supply Shock
·
occurs when there is an unforeseen increase in resource prices that affect the
bulk of the producing economy
·
cause the SRAS curve to shift to the left
GDP falls , unemployment rises ,
and inflation rises
·
the combination of rising Unemployment and inflation is known as a
stagflation
·
this process will eventually reverse itself due to unemployed resources
becoming
cheaper Causing the SRAs to
,
more back to the right increasing
,
GDP
Short-run effect Long-run effect
of
Supply Shock (GRAPH) of
Supply Shock /GRAPH)
P LRAS SRAS 2 LRAS SRAS 2
SRAS
P SRAS
- - 1 The recession caused by
&
.
B hesupplyShoceventsSting
>
-
B
.
2 Moving short-run - 1 An increase in oil
.
prices
=
... ---
Shifts SRAs to the left & SRAS back to its original position
= =---
to B , with lower
equilibrium
-A I
...
, i
real GDP and a higher -----
----- -A
Price level - 2 . Equilibrium moves from
B to potential GDP at
the original price level
AD AD
& >
-
Y Y
To keep in mind...
·
There are two different short-run time periods each with their own SRAS ,
LRAS , and AD curves and thus their own macroeconomic equilibriums
What causes inflation
·
we can look/use the AD/AS analysis to see what
typically causes inflation
going from 1 time period to the next with the dynamic model the SRAS and
·
LRAS curve increase (shifts to the right)
·
If during the same time the AD curve increases faster than the SRAS curve
,
the
result will be a new macroeconomic equilibrium at a
higher Price Level
