Chapter 12: Aggregate Demand and Aggregate Supply (2)

Chapter 12Aggregate Demand and Aggregate SupplyMcGraw-Hill/IrwinCopyright © 2014 by The McGraw-Hill Companies, Inc. All rights reservedAggregate DemandReal GDP desired at each price levelInverse relationshipReal balances effectInterest effectForeign purchases effect12-*Aggregate DemandReal domestic output, GDPPrice levelAD012-*Changes in Aggregate DemandDeterminants of aggregate demandChange in consumer spendingChange in investment spendingChange in government spendingChange in export spending12-*Changes in Aggregate DemandReal domestic output, GDPPrice levelAD1AD3AD2012-*Consumer SpendingConsumer wealthHousehold borrowingConsumer expectationsPersonal taxes12-*Investment SpendingReal interest ratesExpected returnsExpectations about future business conditionsTechnologyDegree of excess capacityBusiness taxes12-*Investment Spending12-*Government SpendingGovernment spending increasesAggregate demand increases (as long as interest rates and tax rates do not change)More transportation projectsGovernment spending decreasesAggregate demand decreasesLess military spending12-*Net Export SpendingNational income abroadExchange ratesDollar depreciationDollar appreciation12-*Net Export Spending12-*Aggregate SupplyTotal real output produced at each price levelRelationship depends on time horizonImmediate short runShort runLong run12-*AS: Immediate Short RunReal domestic output, GDPPrice levelASISRQfImmediate-short-runaggregate supplyP1012-*Aggregate Supply: Short RunReal domestic output, GDPPrice level0QfASAggregate supply(short run)12-*Aggregate Supply: Long RunReal domestic output, GDPPrice levelASLRQf0Long-runaggregatesupply12-*Changes in Aggregate SupplyDeterminants of aggregate supplyChange in input pricesChange in productivityChange in legal-institutional environmentCollectively position the AS curveChanges raise or lower per-unit production costsLO212-*Changes in Aggregate SupplyReal domestic output, GDPPrice levelAS1AS3AS2012-*Input PricesDomestic resource pricesLaborCapitalLandPrices of imported resourcesImported oilExchange rates12-*ProductivityReal output per unit of inputIncreases in productivity reduce costsDecreases in productivity increase costsPer-unit production cost=Total input costTotal outputProductivity=Total outputTotal inputs12-*Legal-Institutional EnvironmentLegal changes alter per-unit costs of outputTaxes and subsidiesExtent of government regulationLO212-*EquilibriumReal domestic output, GDP(billions of dollars)Price level (index numbers)10092502510514abADASReal Output Demanded(billions)Price Level(index number)Real OutputSupplied(billions)$506108$513 508104 512 510100 510 51296 507 51492 502012-*AD Increases: Demand-Pull InflationReal domestic output, GDPPrice levelAD1ASP1P2Q2Q1QfAD2012-*Decreases in AS: Cost-Push InflationReal domestic output, GDPPrice levelADAS1P1P2Q1QfAS2ab012-*Downward Price-Level InflexibilityPrices are downwardly inflexibleFear of price warsMenu costsWage contractsEfficiency wagesMinimum wage law12-*Decreases in AD: RecessionReal domestic output, GDPPrice levelAD1ASP1P2Q1 Q2QfAD2cab012-*The Multiplier EffectShifts in AD embody an “initial change” in spendingPrice levels and average wage levels are becoming more flexible downwardMultiplier =Change in real GDPInitial change in spending12-*