Aggregate Demand and Aggregate Supply

CHAPTER 12
 Chapter Contents
Aggregate Demand
Changes in Aggregate Demand
Aggregate Supply
Changes in Aggregate Supply
Equilibrium in the AD-AS Model
Changes in Equilibrium

12-2
AGGREGATE DEMAND
Real GDP desired at each price level
Inverse relationship:
• Real balances effect
• Interest rate effect
• Foreign purchases effect

12-3
LO12.1
THE AGGREGATE DEMAND CURVE

Aggregate
demand
Price level

AD

0
Real domestic output, GDP
12-4
LO12.1
CHANGES IN AGGREGATE DEMAND
Determinants of aggregate demand: Shift factors
affecting C, I, G, Xn.
Two components involved:
1. Change in one of the determinants
2. Multiplier effect.

12-5
LO12.2
CHANGES IN AGGREGATE DEMAND GRAPHED
Increase in
aggregate
demand

Price level

AD2
Decrease in
aggregate AD1
demand AD3

0
Real domestic output, GDP
12-6
LO12.2
CONSUMER SPENDING
Consumer wealth
Household borrowing
Consumer expectations
Personal taxes

12-7
LO12.2
INVESTMENT SPENDING
Real interest rates
Expected returns:
• Expectations about future business conditions
• Technology
• Changes in excess capacity
• Business taxes

12-8
LO12.2
GOVERNMENT SPENDING
Government spending increases:
• Aggregate demand increases (as long as interest
rates and tax rates do not change)
• More transportation projects
Government spending decreases:
• Aggregate demand decreases
• Less military spending
12-9
LO12.2
NET EXPORT SPENDING
National income abroad
Exchange rates:
• Dollar depreciation
• Dollar appreciation

12-10
LO12.2
AGGREGATE SUPPLY
Total real output produced at each price level.
Relationship depends on time horizon:
• Immediate short run
• Short run
• Long run

12-11
LO12.3
AGGREGATE SUPPLY IN THE IMMEDIATE SHORT RUN

Immediate-short-run
aggregate supply
Price level

P1 ASISR

0 Qf
Real domestic output, GDP

LO12.3 12-12
THE AGGREGATE SUPPLY CURVE (SHORT RUN)
AS

Aggregate supply
(short run)

Price level

0 Qf
Real domestic output, GDP

LO12.3 12-13
AGGREGATE SUPPLY IN THE LONG RUN

ASLR

Price level

Long-run
aggregate
supply

0 Qf
Real domestic output, GDP

LO12.3 12-14
CHANGES IN AGGREGATE SUPPLY
Determinants of aggregate supply: Shift factors
Collectively position the AS curve
Changes raise or lower per-unit production costs

12-15
LO12.4
CHANGES IN AGGREGATE SUPPLY GRAPHED
AS3
AS1
AS2
Decrease in
aggregate supply

Price level

Increase in
aggregate supply

0
Real domestic output, GDP

12-16
LO12.4
INPUT PRICES
Domestic resource prices:
• Labor
• Capital
• Land
Prices of imported resources:
• Imported oil
• Exchange rates
12-17
LO12.4
PRODUCTIVITY
Real output per unit of input
• Increases in productivity reduce costs
• Decreases in productivity increase costs

total output
Productivity = total inputs

total input cost

Per-unit production cost = total output
12-18
LO12.4
LEGAL-INSTITUTIONAL ENVIRONMENT
Legal changes alter per-unit costs of output:
• Business taxes and subsidies
• Government regulation

12-19
LO12.4
THE EQUILIBRIUM PRICE LEVEL AND EQUILIBRIUM REAL GDP

AS
Real Output Real Output
Demanded Price Level Supplied
(Billions) (Index Number) (Billions)
$506 108 $513
Price level (index numbers)

508 104 512

100 510 100 510
a b 512 96 507
92
514 92 502
AD

0 502 510 514

Real domestic output, GDP
(billions of dollars)

12-20
LO12.5
AN INCREASE IN AGGREGATE DEMAND THAT CAUSES DEMAND-
PULL INFLATION
AS

P2
Price level

P1

AD2
AD1

0 Qf Q1 Q2
Real domestic output, GDP
12-21
LO12.6
A RECESSION RESULTING FROM A LEFTWARD SHIFT OF AGGREGATE
DEMAND WHEN THE PRICE LEVEL IS DOWNWARDLY INFLEXIBLE
AS

Price level

b
P1 a
P2 c

AD2 AD1

0 Q1 Q2 Qf
Real domestic output, GDP
12-22
LO12.6
DECREASES IN AD: RECESSION AND CYCLICAL
UNEMPLOYMENT
Prices are downwardly inflexible:
• Fear of price wars
• Menu costs
• Wage contracts
• Efficiency wages
• Minimum wage law
LO12.6 12-23
GLOBAL PERSPECTIVE 12.1

12-24
LO12.6
Source: Organisation for Economic Co-operation and Development (OECD).
A DECREASE IN AGGREGATE SUPPLY THAT CAUSES COST-PUSH
INFLATION
AS2
AS1

P2 b
Price level

P1 a

AD

0 Q1 Qf
Real domestic output, GDP
12-25
LO12.6
GROWTH, FULL-EMPLOYMENT, AND RELATIVE PRICE STABILITY

AS1
AS2

Price level P3 b
P2 c
P1 a

AD2
AD1

0 Q1 Q2 Q3
Real domestic output, GDP

12-26
LO12.6
LAST WORD: STIMULUS AND THE GREAT RECESSION (1 OF 2)

Housing collapse triggers bank failures which leads to

recession.
Federal Reserve intervenes: Lowers short-term interest
rates.
Federal government begins largest peacetime
program of spending.

12-27
LAST WORD: STIMULUS AND THE GREAT RECESSION (2 OF 2)

GDP growth has been disappointing.

High debt load due to low interest rates.
High rate of savings.
Unequal impact.
Price increases rather than output gains.

12-28