Aggregate Demand                             and Aggregate Supply                                                         ...
Economic Fluctuations    • Economic activity           – Fluctuates from year to year    • Recession           – Economic ...
Economic Fluctuations    • Key facts about economic fluctuations           1. Economic fluctuations are irregular and     ...
Figure 9U.S. Real GDP Growth since 1900 Over the course of U.S. economic history, two fluctuations stand out as especially...
Figure 1A Look at Short-Run Economic Fluctuations (c) This figure shows real GDP in panel (a), investment spending in pane...
Short-Run Economic Fluctuations      • AD-AS model             – Model of aggregate demand (AD) &               aggregate ...
Short-Run Economic Fluctuations      • Aggregate-demand curve             – Shows the quantity of goods and               ...
Short-Run Economic Fluctuations      • Aggregate-supply curve             – Shows the quantity of goods and services      ...
Figure 2Aggregate Demand and Aggregate Supply                       Price                       Level                     ...
Figure 3The Aggregate-Demand Curve                      Price                      Level                              1. A...
Aggregate-Demand Curve      • The AD curve might shift:             – Changes in consumption             – Changes in inve...
Aggregate-Demand Curve      • Changes in government purchases, G             – Policymakers – change government           ...
Aggregate Supply Curve    • Short run           – Aggregate-supply curve is upward sloping           – A higher price rais...
Figure 6The Short-Run Aggregate-Supply Curve                      Price                                                   ...
Causes of Economic Fluctuations    • Assumption           – Economy begins in long-run equilibrium    • Long-run equilibri...
Exhibit 7The Long-Run Equilibrium                       Price                                          Long- run          ...
Causes of Economic Fluctuations    • Shift in aggregate demand           – Wave of pessimism (stock market crash)         ...
Exhibit 8A Contraction in Aggregate Demand              Price                                                 Short-run ag...
The Recession of 2008–2009       • 2008-2009, financial crisis, severe         downturn in economic activity              ...
The Recession of 2008–2009       • Three policy actions to shift AD rightward              – The Fed                      ...
Exhibit 8bEffect of Policy Actions              Price                                                 Short-run aggregate ...
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Ch23

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Ch23

  1. 1. Aggregate Demand and Aggregate Supply PowerPoint Slides prepared by: Andreea CHIRITESCU Eastern Illinois University© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 1permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
  2. 2. Economic Fluctuations • Economic activity – Fluctuates from year to year • Recession – Economic contraction – Period of declining real incomes and rising unemployment • Depression – Severe recession© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 2permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
  3. 3. Economic Fluctuations • Key facts about economic fluctuations 1. Economic fluctuations are irregular and unpredictable • The business cycle 1. Most macroeconomic variables fluctuate together • Recessions – economy-wide phenomena • As output falls, income falls and unemployment rises© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 3permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
  4. 4. Figure 9U.S. Real GDP Growth since 1900 Over the course of U.S. economic history, two fluctuations stand out as especially large. During the early 1930s, the economy went through the Great Depression, when the production of goods and services plummeted. During the early 1940s, the United States entered World War II, and the economy experienced rapidly rising production. Both of these events are usually explained by large shifts in aggregate demand.© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 4permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
  5. 5. Figure 1A Look at Short-Run Economic Fluctuations (c) This figure shows real GDP in panel (a), investment spending in panel (b), and unemployment in panel (c) for the U.S. economy using quarterly data since 1965. Recessions are shown as the shaded areas. Notice that real GDP and investment spending decline during recessions, while unemployment rises.© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 5permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
  6. 6. Short-Run Economic Fluctuations • AD-AS model – Model of aggregate demand (AD) & aggregate supply (AS) – Most economists use it to explain short- run fluctuations in economic activity • Around its long-run trend© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 6permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
  7. 7. Short-Run Economic Fluctuations • Aggregate-demand curve – Shows the quantity of goods and services – That households, firms, the government, and customers abroad – Want to buy at each price level – Downward sloping© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 7permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
  8. 8. Short-Run Economic Fluctuations • Aggregate-supply curve – Shows the quantity of goods and services – That firms choose to produce and sell – At each price level – Upward sloping© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 8permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
  9. 9. Figure 2Aggregate Demand and Aggregate Supply Price Level Aggregate supply Equilibrium price level Aggregate demand Equilibrium Quantity of output Output Economists use the model of aggregate demand and aggregate supply to analyze economic fluctuations. On the vertical axis is the overall level of prices. On the horizontal axis is the economy’s total output of goods and services. Output and the price level adjust to the point at which the aggregate-supply and aggregate-demand curves intersect.© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 9permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
  10. 10. Figure 3The Aggregate-Demand Curve Price Level 1. A decrease in the price level . . . P1 2. . . . increases the quantity of P2 goods and services demanded Aggregate demand Y1 Y2 Quantity of Output A fall in the price level from P1 to P2 increases the quantity of goods and services demanded from Y1 to Y2. There are three reasons for this negative relationship. As the price level falls, real wealth rises, interest rates fall, and the exchange rate depreciates. These effects stimulate spending on consumption, investment, and net exports. Increased spending on any or all of these components of output means a larger quantity of goods and services demanded.© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 10permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
  11. 11. Aggregate-Demand Curve • The AD curve might shift: – Changes in consumption – Changes in investment – Changes in government purchases – Changes in net exports© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 11permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
  12. 12. Aggregate-Demand Curve • Changes in government purchases, G – Policymakers – change government spending at a given price level • Build new roads – Increase in government purchases • Aggregate demand - shifts right© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 12permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
  13. 13. Aggregate Supply Curve • Short run – Aggregate-supply curve is upward sloping – A higher price raises the quantity of goods and services supplied • Long run aggregate supply – Recall Chapter 17 • Price level does not affect the long-run determinants of GDP: – Supplies of labor, capital, and natural resources – Available technology© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 13permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
  14. 14. Figure 6The Short-Run Aggregate-Supply Curve Price Short-run Level aggregate 1. A decrease in supply the price level . . . P1 P2 2. . . . reduces the quantity of goods and services supplied in the short run Y2 Y1 Quantity of Output In the short run, a fall in the price level from P1 to P2 reduces the quantity of output supplied from Y1 to Y2. This positive relationship could be due to sticky wages, sticky prices, or misperceptions. Over time, wages, prices, and perceptions adjust, so this positive relationship is only temporary.© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 14permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
  15. 15. Causes of Economic Fluctuations • Assumption – Economy begins in long-run equilibrium • Long-run equilibrium: – Intersection of AD and LRAS curves • Output - natural rate • Actual price level – Intersection of AD and short-run AS curve • Expected price level = Actual price level© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 15permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
  16. 16. Exhibit 7The Long-Run Equilibrium Price Long- run Level aggregate supply Short-run aggregate supply Equilibrium A price Aggregate demand Quantity of Output The long-run equilibrium of the economy is found where the aggregate-demand curve crosses the aggregate-supply curve (point A).© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 16permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
  17. 17. Causes of Economic Fluctuations • Shift in aggregate demand – Wave of pessimism (stock market crash) – Aggregate demand shifts left – Short-run • Output falls • Price level falls© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 17permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
  18. 18. Exhibit 8A Contraction in Aggregate Demand Price Short-run aggregate Level supply, AS1 P1 A B P2 1. A decrease in aggregate demand . . . AD2 Aggregate demand, AD1 Y2 Y1 Quantity of Output 2. . . . causes output to fall in the short run . . . A fall in aggregate demand is represented with a leftward shift in the aggregate-demand 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.© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 18permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
  19. 19. The Recession of 2008–2009 • 2008-2009, financial crisis, severe downturn in economic activity – Worst macroeconomic event in more than half a century • 2006-2008: housing prices began to fall – Substantial rise in mortgage defaults and home foreclosures – Financial institutions that owned mortgage-backed securities • Huge losses© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 19permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
  20. 20. The Recession of 2008–2009 • Three policy actions to shift AD rightward – The Fed • Cut its target for the federal funds rate from 5.25% in September 2007 to about zero in December 2008 • Started open market operations – Treasury • Lent loans to banks and became part owner • Government – temporarily became a part owner of these banks – January 2009, Barack Obama • $787 billion stimulus bill of government spending & tax cuts© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 20permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.
  21. 21. Exhibit 8bEffect of Policy Actions Price Short-run aggregate Level supply, AS1 P1 A B P2 3. Policy aims at return aggregate demand to AD1 . . . 1. A decrease in aggregate demand . . . AD2 Aggregate demand, AD1 Y2 Y1 Quantity of Output 2. . . . causes output to fall in the short run . . . A fall in aggregate demand is represented with a leftward shift in the aggregate-demand 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.© 2011 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as 21permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

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