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Chapter 5 Macroeconomics Dornbusch, Fischer, Startz (9/e) 1 Aggregate Supply and Demand 1 Aggregate Model 2 - The aggregate demand - aggregate supply model is the basic macroeconomic tool for studying output fluctuations and determination of price level and the inflation rate. - The aggregate supply (AS) curve describes, for each given price level, the quantity of output firms are willing to supply - The aggregate demand (AD) curve shows the combinations of the price and level of output at which the goods and money markets are simultaneously in equilibrium. Equilibrium 3 Change in Nominal Money Supply and AD Shift 4 Change in AS 5 The Aggregate Supply Curve 6 - Classical AS Curve (long run): - The classical aggregate supply curve is vertical, indicating that

. .Price level does not depend on GDP 8 9 The Frictional Unemployment 10 .Potential GDP grows over time and nation accumulates resources The Aggregate Supply Curve 7 .Due to unemployment. The Aggregate Demand Curve 11 .The key to the aggregate demand relation between output and prices is that aggregate demand depends on real money supply.the same amount of goods will be supplied whatever the price level. indicating that firms will supply whatever amount of goods demanded at the existing price level.Labour market is in equilibrium with full employment of the labour force . .The Keynesian aggregate supply curve is horizontal.The real money supply is the value of the money provided by the central bank and the banking system Value of Money 12 . .Keynesian AS Curve (short run) .The aggregate curve shows the combinations of the price level and level of output at which the goods and money markets are simultaneously in equilibrium.The natural rate of unemployment is the rate of unemployment arising from normal labor market frictions that exist when the labour market is in equilibrium. additional resources available . Y* .Frictional unemployment – people temporary out of job or interested to change job .Level of output is potential GDP.

AD curve represents equilibrium in both the goods and money markets.The inverse relation between price and output gives the downward slope of AD.The aggregate demand relation between output and prices is dependent on the real money supply. Value of Money 14 Aggregate Demand 15 .An increase in the money supply shifts AD upward for any given .The aggregate demand relation between output and price is IS-LM model. . interest rate increase and investment falls.When real money supply falls.V is velocity of money .Increase in money supply .Expansionary policies move AD curve to the right .Real money supply is the value of money provided by the banking system.When V is constant.When real money supply rises.Confidence of consumers and investors Aggregate Demand 13 . .. interest rate falls and investment rises. which is sophisticated. MV = PY is AD curve.Increase in government spending . The Quantity Theory of Money 16 .Quantity of money = M X V .Cuts in taxes .Expansionary Policies . any increase in Y must be offset by decrease in P and vice versa.Nominal GDP = P X Y . overall aggregate demand rises.MV = PY . . . overall aggregate demand falls. . . With money supply constant.

No effect of price .Expansionary policy.Some believe tax-cut will increase AS and will increase tax collection.Supply side policies: . Tax Cut and Supply Side Economics 22 .AS vertical because full employment .Move AS curve to the right by increasing potential GDP.Removing unnecessary regulations .Only effect increase in price level.value of Y.Only effect is output and employment The Classical Case of AD 20 .Technological progress .Efficient legal system .Equilibrium: AD = Keynesian AS . Shift in Aggregate Demand 18 Keynesian Case of AD 19 . Supply Side Economics 21 .Expansionary policies cause shift to AD to right . Aggregate Demand 17 . no change in output level. . AD shifts to the right .An increase in the nominal money stock shifts the AD schedule up by exactly in proportion to the increase in nominal money.

AS shift smaller than AD shift. equilibrium moves to E’’ from E. but AD increases more .Tax cut initially increase both AD and AS. AD and AS in Long-Run 23 Exercise 24 . . how would the reduction affect output and the price level in the short run? Show how the aggregate supply and demand curves should be affected.Initially economy moves to E’ from E for purely demand effect (AD’).. rise in deficit and permanent price rise. in both cases. .Less tax collection. Tax collection falls .If the government were to reduce income taxes.

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