Chapter 8: Aggregate Demand and Aggregate Supply

Chapter 8Aggregate Demand and Aggregate SupplyChapter OutlineAggregate DemandAggregate SupplyShifts in Aggregate Demand and Aggregate SupplyCauses of InflationSupply-Side EconomicsAggregate DemandAggregate Demand: the amounts of real domestic output which domestic consumers, businesses, governments, and foreign buyers collectively will desire to purchase at each possible price levelFigure 1 Aggregate DemandRGDPPIADWhy Aggregate Demand is Downward SlopingReal Balances EffectBecause higher prices reduce real spending power, prices and output are negatively related.Foreign Purchases EffectWhen domestic prices are high, we will export less to foreign buyers and we will import more from foreign producers. Therefore higher prices leads to less domestic output.Interest Rate Effecthigher prices lead to inflation which leads to less borrowing and a lowering of RGDP Aggregate SupplyAggregate Supply: the level of real domestic output available at each possible price levelFigure 2 The Aggregate Supply CurveRGDPPIKeynesian RangeClassical Range Intermediate RangeThe Ranges of ASKeynesian RangeLarge amounts of unemployment make it so that increases in aggregate demand have no affect on wages or prices.Classical RangeFull employment makes it so that increases in aggregate demand only increase wages or prices.Intermediate RangeSome sectors of the economy reach full employment more quickly than others.Variables that Shift Aggregate DemandTaxesInterest RatesConfidenceStrength of the DollarGovernment SpendingDeterminants of ADVariableGDP Component AffectedC,I,G,XEffect of an increase on ADEffect of a decrease on ADTaxesC,IDecrease soAD Interest RatesC,IDecrease soAD ConfidenceC,IIncrease soAD =>Decrease soAD Government SpendingGIncrease soAD =>Decrease soAD <=Figure 3 AD IncreasesAD’ASADRGDPPIPI*RGDP*PI’RGDP’Figure 4 AD DecreasesAD’ASADRGDPPIPI*RGDP*PI’RGDP’Variables that Shift ASInput PricesProductivityGovernment RegulationDeterminants of ASVariableEffect of an Increase on ASEffect of an Decrease on ASInput PricesDecrease soASIncrease so ASProductivityIncrease so ASDecrease soASGovernment RegulationDecrease soASIncrease so ASFigure 5 Increase in ASASADRGDPPIPI*RGDP*AS’PI’RGDP’Figure 6 Decrease in ASRGDPASADPIPI*RGDP*AS’PI’RGDP’Causes of InflationDemand Pull Inflation: inflation caused by an increase in aggregate demand Cost Push Inflation: inflation caused by a decrease in aggregate supplySupply-Side EconomicsSupply-side economics: government policy intended to influence the economy via aggregate supply by lowering input costs and reducing regulation