Chapter

14
 chaser's memb
eam er
Dr s

Khor Wei Cheng

Angela Ling Siew 302163 Nur’ain Nabilah
Wei binti Mohd Bakhori
294201 295644

Nurul Shahirah Ammar Zakwan

binti Osman Bin Abdul Rahman
295562 297450
Today's Agenda

1 Aggregate Demamd 3 Macroeconomic

equilibrium

2 Aggregate Supply 4 Monetary and fiscal

policy

5 Goverment budget
Introduction
What is Aggregate Demand?
Aggregate demand is the quantity demanded
of all goods and services (Real GDP) at different
price levels, ceteris paribus

The quantity of real GDP demanded, Y, is the

total amount of final goods and services
produced in the economy that people,
businesses, governments, and foreigners plan
to buy.
 Formula
C= Sum of consumption expenditures
I= Investment
G= Government expenditure
Y=C+I+G+(X-M)
X= Export
M= Import
(X-M)= Net Exports
 Aggregate Demand Curve
Aggregate demand is the relationship
between the quantity of real GDP
demanded (Y) and the price level (P).
AD curve slopes downwards.

Reason

Wealth Effect
Interest Rate Effect
The Exchange Rate/International Trade
Effect
 Wealth Effect

A rise in the price level,

other things remaining the
same, decreases the
quantity of real wealth
(money, stocks, etc.), the
quantity of real GDP
demanded (Y) decreases.
To restore their real
wealth, people increase
saving and decrease
spending.
P
 Interest Rate
Effect

A rise in the price

level, other things
remaining the same,
decreases the real
value of money and
raises the interest
rate.
When the interest rate
rises, people borrow
and spend less, so the
quantity of real GDP
demanded (Y) decreases.
 The exchange rate/
International Trade Effect

A rise in the price

level, other things
remaining the same,
increases the price of
domestic goods relative
to foreign goods.
So imports increase and
exports decrease, which
decreases Y or the
quantity of real GDP
demanded.
Deriving the AD Curve
 Deriving the AD Curve
An increase in P increases the demand for money (Mdt) and shifts the money
demand (Md)curve to the right as shown in Figure 15.2(a).
With the quantity of money remaining the same , an increase in the money
demand raises the interest rate from 6 per cent to 9 per cent. The increase in
interest rate causes investment to fall, as indicated in Figure 15.2(b).
Aggregate expenditure is a composition of consumption (C), Investment (I),
government spending (G) and net exports (X-M).
A decrease in planned investment reduces planned aggregate expenditure (AE)
and causes equilibrium output (Y) to fall [See Figure 15.2 (c)].
An increase in the overall price level causes the level of aggregate output to fall or
vice versa. This effect is called “interest rate effect.”
In short, the interest rate effect works as follows:
P ↑ »» Md ↑ »» r ↑ »» I ↓ »» Y ↓
Aggregate Expenditure and Aggregate Demand
The total planned aggregate expenditure (AE) consists of the total planned
spending by households (C), firms (I), government (G) and net exports (X-M).
≡
In a closed economy, at equilibrium, planned aggregate expenditure (AE C + I +
G) is equal to aggregate output (Y). Thus, Y = C + I + G (equilibrium condition).
At every point along the aggregate demand curve, the aggregate quantity of
output demanded is exactly equal to the planned aggregate expenditure.
When the overall price level rises, eventually the planned aggregate expenditure
decreases, moving down along the aggregate demand curve . However, the
aggregate demand curve represents more than just planned aggregate
expenditure.
Each point on the AD curve represents the particular level of planned aggregate
expenditure that is consistent with equilibrium in the goods market and money
market at the given price.
Difference of change in Quantity Demand (Qd) and
Aggregate Demand (AD)

A change in the quantity

Change in Qd
demanded of Real GDP is
graphically represented as a
movement from one point, A, on
AD1 to another point, B, on
AD1.
A change in the quantity
demanded of Real GDP is the
result of a change in the price
level.
Difference of change in Quantity Demand (Qd) and
Aggregate Demand (AD)

Change in Ad
A change in aggregate demand
is graphically represented as
a shift in the aggregate
demand curve from AD1 to AD2.
Change in aggregate demand is
the result of other factor
other than price level.
Factors That Shift Aggregate Demand Curve
 ↑ ↑ ↑
1. Wealth (Wealth , C , AD )
2. Expectations about future prices and income (Expect higher
C Changes ↑ ↑ ↑ ↑ ↑ ↑
future prices ,C ,AD , Expect higher future income ,C ,AD )
↓ ↑ ↑
3. interest rate (Interest Rate ,C ,AD )
↓ ↑ ↑
4. Income taxes (Income taxes ,C ,AD )

1. Interest Rate (Interest rates↓,I↑,AD↑)

2. Expectations about Future Sales (Optimistic about future
sales,I↑ AD↑)
I Changes
3. Business taxes (Business taxes↓,I↑,AD↑)

Incresed fiscal spending (raises the amount of the budget for

G Changes
↑
the agricultural sector), G , AD↑

1. Foreign real national income (Foreign Real National

(X-M) Changes ↑ ↑ ↑ ↑
income ,EX ,NX ,AD )
↑ ↓ ↑ ↑
2. Exchange rate (US$ appreciates,EX and IM ,NX ,AD )
 Factors That Shift Aggregate Demand Curve (C,I,G)
Fiscal Policy- Fiscal policy is the government’s attempt to influence the economy
by setting and changing taxes, making transfer payments, and purchasing goods
and services.
Monetary policy- The Fed’s attempt to influence the economy by changing the
interest rate and adjusting the quantity of money is called monetary policy.
 AGGREGATE
What is aggregate supply?
SUPPLY
Aggregate supply is the relationship between the quantity of real GDP
supplied and the price level. It is also known as the price or output
response curve.
The quantity of real GDP supplied is the total quantity that firms plan to
produce during a given period.

We distinguish two time frames associated with different states

of the labor market:
- Long-run aggregate supply
- Short-run aggregate supply
 Introduction
Short-Run AS (SAS) is the relationship between the
SHORT-RUN quantity of real GDP (Y) supplied and the price level
(P) when the money wage rate (w), the prices of
AGGREGATE SUPPLY other resources, and potential GDP remain
constant.
A rise in the P with no change in the w and other
factor prices, will increases the quantity of real GDP
supplied.
The SRAS curve is upward sloping. Indicating a
positive relationship between P with G/S supplied.
 3 At price level Po, the
quantity of aggregate
output is Yo.; if prices
rise to P1, the amount of
aggregate output
increases to Y1.

Changes occur along the

aggregate supply curve
Figure 15.4 Short run aggregate
from point a to point b.
supply curve
Determinants of Positive Sloping Aggregate Supply Curve
The Sticky-Wage Theory
The Sticky-Price
Theory Misperception of worker

Short Run Aggregate Supply Curve (SRAS): Classical and Keynesian

-The aggregate supply curve can be divided into two categories:

Classical and Keynesian.
-The difference between Classical and Keynesian aggregate supply is
based on the assumption held in derivation.
Classical Aggregate
Suply Cuve
Figure 15.5 Short run classical
aggregate supply curve (SRAS)
There are two assumptions held in Classical
analysis in the derivation of the short run
aggregate supply curve.
First, price (P) and wage (W) are flexible. It
implies that a switch in wages is based on a
switch in price, AW = AP. For instance, if price
level decreases, wages also decrease by the
same percentage, thus real wages (W/P)
remain unchanged.
Second, the economy is always in equilibrium.
The economy is self-adjusted until it achieves
equilibrium.
Hence, the Classical aggregate supply curve in
the short run is vertical as in Figure 15.5.
-Based on the figure, it indicates that the
aggregate production level stays at Yo even
though prices change.
Keynesian Aggregate Supply Curve

The assumption held in the Keynesian analysis is that price and wages are
sticky and that the economy is not always in equilibrium.

Price and wages are sticky or inflexible meaning that wages adjustment is not
necessarily the same as price change.

In other words, wages cannot decrease when the price level decreases but can
increase when the price level increases. Thus, AW ≠ AP.

The economy is not always in equilibrium meaning that at a certain period the
economy may encounter problems such as unemployment.
 The Keynesian aggregate supply curve in
the short run can be divided into three
phase :
First, the horizontal range implies that the
economy is in recession and that
unemployment is a problem.

Second, the intermediate range implies

that an expansion of aggregate output is
accompanied by a rise in the price level,
range of b to c.

Third, The vertical range (cd) (economy at

potential output) implies that any increase
Figure 15.6 Keynesian Aggregate Supply Curve in the in price will not produce additional
Short Run aggregate output, range of c to d.
 Wage Rate

Technology Supply Shock

Determinants of
Aggregate Supply

Price of
nonlabour input Price

Productivity
 INTRODUCTION
-In the long run, an economy's production
of goods and services depends on its
LONG-RUN supplies of labor, capital, and natural
AGGREGATE resources and on the available technology
SUPPLY used to turn these factors of production
into goods and services.

-The price level does not affect these

variables in the long run.
 DEFINITION
Natural Real GDP: The Real GDP that is produced at the natural
unemployment rate. Also, the Real GDP that is produced when the
economy is in long-run equilibrium.

Long-Run Aggregate Supply (LRAS) Curve: A curve that represents the

output the economy produces when wages and prices have adjusted to
their final equilibrium levels and when workers do not have any
relevant misperceptions. The LRAS curve is a vertical line at the level of
Natural Real GDP
  he long-run
T
aggregate-supply
curve is vertical at the
natural rate of output.

This level of
production is also
referred to as potential
GDP or full-
employment output.

An increase in P does
not affect
any of these,
so it does not
The Long Run of Aggregate affect natural rate of
Supply Curve output.
 Aggregate Supply: Changes in Potential GDP

When potential GDP increases, both the LAS and SAS

curves shift rightward.

Potential GDP changes for four reasons:

An increase in the full-employment quantity of labor
An increase in the quantity of capital (physical or human)
An advance in technology
Supply shocks (positive and negative)
-The figure shows the
effect of an increase in
potential GDP.

-The LAS curve shifts

rightward and the SAS
curve shifts along with the
LAS curve.
Changes in the Money Wage Rate

The figure shows the effect of a rise

in the money wage rate.

Short-run aggregate supply

decreases and the SAS curve
shifts leftward.

Long-run aggregate supply does

not change.
MACROECONOMIC
Macroeconomic equilibrium occurs when aggregate demand is
equivalentr to aggregate supply, or when both curves intersect.

EQUILIBRIUM

MACROECONOMIC EQUILIBRIUM IN
SHORT RUN
The equilibrium occurs when the aggregate demand
curve (AD) equals to short run aggregate supply
curve (SRAS); the price level and aggregate output
equilibrium are at P0 and Y0.
At P1, there is disequilibrium where the quantity of
aggregate supply (Y0) is more than the quantity of
aggregate demand (Y1).
It is also known as excess of aggregate supply or
surplus.
At price P2, there is disequilibrium where the
quantity of aggregate supply (Y0) is less than the
quantity of aggregate demand (Y2).
It is also known as shortage of aggregate supply or
excess of aggregate demand.
 MACROECONOMIC EQUILIBRIUM IN
SHORT RUN

Changes in Aggregate Demand

Assuming the initial equilibrium is at e0, price P0 and

quantity of aggregate output Y0.
For example, when government spending rises, the
aggregate demand curve moves to the right, AD1.
At P0, there is excess aggregate demand (Y0Y1 ). This
encourages price level to rise and a new equilibrium is
achieved at e1, price level P1, and quantity
of aggregate output, Y0.
Conversely, when there is a decrease in government
spending , the aggregate demand curve shifts to the left,
AD2, and a new equilibrium is achieved at e2.
 MACROECONOMIC EQUILIBRIUM IN
SHORT RUN

Changes in Aggregate Supply

Assuming the initial equilibrium is at e0, price P0, and

quantity of aggregate output Y0.
For example, due to an increase in technology, the
aggregate supply curve shifts to the right, SRAS1.
At P0, there is excess of aggregate supply (Y0Y1). This
results in a lower price level and an expansion in aggregate
output.
Thus a new equilibrium is achieved at e1, price level P1, and
quantity of aggregate output, Y1.
Conversely, when there is a decrease in technology or
productivity, the AS curve shifts to the left, SRAS2, and a
new equilibrium is reached e2.
 MACROECONOMIC EQUILIBRIUM IN
LONG RUN

Changes in Aggregate Demand

Assume LRAS=AD is at e0, price p0 and quantity

of aggregate output y0.
When consumption increases, the AD curve
shifts to the right, AD1.
At p0, there is an excess of AD (Y0Y1) which
causes the price level to rise an reach e1, at
price level p1, and Y0.
When consumption falls, the AD curve shifts to
the left, AD2 at e2.
 MACROECONOMIC EQUILIBRIUM IN
LONG RUN

Changes in Aggregate Supply

Assume LRAS=AD is at e0, price p0 and quantity of

aggregate output y0.
For example, if global petroleum price fall, the
aggregate supply curve shifts to the right, LRAS1.
At P0, there is an excess of aggregate supply (Y0Y1)
which leads to a decrease in price level and an
increase in aggregate comput.
The new equilibrium is at e1 price level P1, and
quantity of aggregate output Y1.
Conversely, if in global petroleum price increase, the
aggregate supply curve shifts to the left, LRAS2, and
the new equilibrium is et2 (P2Y2).
Monetary
policy Open market operation (OMO)
It is a policy set by Bank Negara
Required reserve ratio (RRR)
Malaysia(BNM) to accomplish broader
objectives like high employment and Discount rate (DR)
price stability. There is 3 monetary
policy
Fiscal
policy Tax
Fiscal policy is the use of government Goverment expenditures
spending and taxation to influence the
economy. Governments typically use
fiscal policy to promote strong and
sustainable growth and reduce poverty.
 Effect of
Expansionary
When there is an increase in
AD (AD⁰ to AD¹), the level of
output increases from Y⁰ to Y
gtp. The same goes for a price
level.
 Effect of
Contractionary
When AD decreased (AD⁰ to
AD¹), the level of output falls
from Y⁰ to Ygtp. The same
goes for the price level.
Goverment
Budget
A government budget is a financial plan Budget balance
outlining the government's expected
Budget deficit
revenues and proposed expenditures
for a specific period, typically a fiscal Budget surplus
year. It serves as a comprehensive
blueprint that details how the
government intends to generate income
and allocate funds to various sectors
and programs. There is three type of
budget.
 Have a
great
day
ahead.