MACROECONOMICS

Le Phuong Thao Quynh

FACULTY OF INTERNATIONAL ECONOMICS
Mobile: 0987027398
Email: phuongthaoquynhle@yahoo.com.vn
 AGGREGATE DEMAND AND AGGREGATE
SUPPLY

 CONTENT:
- The AD – AS model
- Analyze short run economic fluctuations by using
AD – AS model
- Focus on two factors: Yield (Y or GDPr) and price
(P)
SHORT-RUN ECONOMIC FLUCTUATIONS

 Economic activity fluctuates from year to year:

 In most years, productions of goods and services rises
 In recent years, Vietnam production rises about 5-6%
per year
 In some years, this normal growth does not occur =>
recession
 Recession is the period with falling income and
increasing unemployment. If it is more severe, it is
called depression.
THREE KEY FACTS ABOUT ECONOMIC
FLUCTUATIONS

 Economic fluctuations are irregular and

unpredictable

 Most macroeconomic quantities fluctuate together:

real GDP, investment, unemployment rate etc.

 As output falls, unemployment rises

 THE BASIC MODEL OF ECONOMIC
FLUCTUATIONS
 Economists use the model of aggregate demand
and aggregate supply to explain short-run
fluctuations in economic activity around its long-run
trend.
 Price level as measured by the CPI

 Aggregate Output as measured by real GDP.

 THE BASIC MODEL OF ECONOMIC
FLUCTUATIONS
 The aggregate demand (AD) curve shows the
quantity of goods and services that households,
firms, the government and the foreign sector want
to buy at each price level.

 The aggregate supply (AS) curve shows the

quantity of goods and services that firms produce
and sell at each price level.
THE AD – AS MODEL
THE AD CURVE
WHY THE AD CURVE IS DOWNWARD SLOPING?

AD = C + I + G+ NX = C + I + G + X – M

 C: consumption
 I: investment
 G: government purchases
 X: export
 M: import
 WHY THE AD CURVE IS DOWNWARD SLOPING?

AD slopes downward due to 3 effects:

 P & C : The Wealth effect

 A decrease in the price level raises the real value of money and
makes consumers wealthier, which in turn encourages them to
spend more. C => AD
WHY THE AD CURVE IS DOWNWARD SLOPING?

AD slopes downward due to 3 effects:

 P & I : The interest rate effect

 A lower price level reduces the interest rate, encourages greater
spending on investment goods, and thereby increases AD

 P & NX : The exchange – rate effect

A lower price level reduces the interest rate, the real value of the VND
decreases, and this encourages net export => Increase AD
 MOVEMENT ALONG AD CURVE
 Changes in the price level (P) cause a movement along
the AD Curve.
 WHY AD CURVE MIGHT SHIFT?
 Changes of factors other than P → shift of AD
curve.
 Expectations
 Wealth

 Size of the capital stock

 Government economic policy

- Fiscal policy: ∆G & ∆T

- Monetary policy: ∆money supply & ∆i
 WHY AD CURVE MIGHT SHIFT?
AD = C + I + G + NET EXPORTS

 Shifts arising from Consumption. Eg: government

cuts taxes, it encourages people to spend more (C
increases => AD increases and shifts to the right

 Shifts arising from Investment. Eg: firms become

optimistic about future business conditions => invest
more => AD increases and shifts to the right
 WHY AD CURVE MIGHT SHIFT?
AD = C + I + G + NET EXPORTS

 Shifts arising from Government Purchases. Eg: state

governments start building more highways, the result is
a greater AD, so AD shifts to the right.

 Shifts arising from Net Exports. Eg: When Europe

recovers from its recession, it starts buying VN. goods
again, and AD curve shifts to the right.

 Conversely, a decrease in C, I, G and NX will result in a

reducing AD and the AD curve shifts to the left
WHY AD CURVE MIGHT SHIFT?
 THE AS CURVE
 The aggregate supply curve shows the level of
production at each price level.
 In the long run, the aggregate-supply curve is
vertical.
 In the short run, the aggregate-supply curve is
upward sloping.
 THE LONG RUN AS CURVE (LRAS)

LRAS (or real GDP in long run) only depends on labor, capital, and natural
resources and on the available technology.
Because the price level does not affect the long-run determinants of real
GDP, the long-run aggregate-supply curve is vertical,
 THE LONG RUN AS CURVE (LRAS)
 The long-run level of production is sometimes
called potential output or full-employment output.
we call it the natural rate of output because it
shows what the economy produces when
unemployment is at its natural, or normal, rate.
 THE LRAS MIGHT SHIFT
 Shifts arising from:
- Labor (L)
- Capital (K)
- Natural Resources (N)
- Technological Knowledge (Tech)

 Any change in the economy that alters the natural

rate of output shifts the LRAS curve.
THE SHORT RUN AGGREGATE SUPPLY
CURVE (SRAS)
 WHY SRAS SLOPES UPWARD IN
SHORT RUN?
 In the short run, an increase in the overall level of
prices in the economy tends to raise the quantity of
goods and services supplied.
 WHY SRAS SLOPES UPWARD IN
SHORT RUN?

 The Sticky Wage Theory:

Nominal wages are slow to adjust to changing economic
conditions (wages are “sticky” in the short run due to long-term
contracts between workers and firms) => P goes down, real
wage increases => Firms’ profit decrease => Cut employment
and reduce AS
 WHY SRAS SLOPES UPWARD IN
SHORT RUN?
- The Sticky-Price Theory: An unexpectedly low price
level leaves some firms with higher- than-desired prices, which
depresses their sales and leads them to cut back production.

- The Misperceptions Theory: An unexpectedly low price

level leads some suppliers to think their relative prices have
fallen, which induces a fall in production.
 MOVEMENT ALONG AS CURVE
 Changes in price level lead to movement along AS
curve
WHY THE SRAS CURVE MIGHT SHIFT?
 Changes of factors other than Price level → shift of
SRAS curve:
1) commodity prices (cost of inputs)
2) nominal wages
3) productivity: L, K, N and tech (same
to LRAS)
THE LONG RUN EQUILIBRIUM
 ECONOMIC FLUCTUATIONS

4 steps for analyzing economic fluctuations:

1. Decide whether the event shifts the AD or AS curve
(or perhaps both).
2. Decide in which direction the curve shifts.
3. Use the diagram of AD and AS to see how the shift
changes output and the price level in the short run.
4. Use the diagram of AD and AS to analyze how the
economy moves from its new short-run equilibrium to
its long-run equilibrium.
 TWO CAUSES OF ECONOMIC
FLUCTUATIONS

 The Effects of a Shift in Aggregate Demand

- A contraction in AD:

Eg: war oversea, a scandal in government, a crash in

stock market => consumers and firms become
pessimistic about future => reduce consumption and
investment => reduce AD
A CONTRACTION IN AD
 A CONTRACTION IN AD
 A fall in AD is represented with a leftward shift in the
AD curve from AD1 to AD2.
 In the short run, the economy moves from point A to
point B. Output falls from Y1 to Y2, and the price
level falls from P1 to P2.
 If the policymakers do nothing, over time: Y2 < Y1
=> increase nominal wage =>SRAS curve shifts to
the right from AS1 to AS2, and the economy
reaches point C. In the long run, the price level falls
to P3, and output returns to its natural rate, Y1.
 A CONTRACTION IN AD
 Policymakers could take action to increase AD and
let AD shift back by using expansionary Fiscal and
Monetary Policy:

 Expansionary Fiscal Policy: Increase G and

reduce T => Increase AD

 Expansionary Monetary Policy: Increase MS

(money supply) and reduce i (interest rate) =>
Increase AD.
 A CONTRACTION IN AD
To sum up:
 In the short run, shifts in AD cause fluctuations in
the economy’s output of goods and services.
 In the long run, shifts in AD affect the overall price
level but do not affect output.
 Policymakers who influence AD can potentially
mitigate the severity of economic fluctuations.
 THE EFFECTS OF A SHIFT IN AS
 A decrease in one of the determinants of AS shifts
the curve to the left:
- Output falls below the potential yield.
- Unemployment rises.
- The price level rises.
- Stagflation results! (a period of recession and
inflation.)
AN ADVERSE SHIFT IN AS
 AN ADVERSE SHIFT IN AS
 Stagflation
 Output falls and prices rise.

 Policymakers who can influence AD cannot

offset both of these adverse effects

simultaneously.
 POLICY RESPONSES TO RECESSION
 Policymakers may respond to a recession in one of
the following ways:
- Do nothing and wait for prices and wages to adjust.
- Take action to increase AD by using monetary and
fiscal policy.
POLICY RESPONSES TO RECESSION
 QUESTIONS
 Explain whether each of following events will have impact
on SRAS and/or AD. Show the changes in Y and P
1. Household decides to save more because of pessimism
about future.
2. US grows faster and import more goods from Vietnam.
3. Oil prices sharply increase.
4. The government decides to reduce tax on imported raw
materials.
5. The government decides to increase tax on imported
goods.