aggregate demand and supply

1. AD-AS
Fiscal Policy
Analyzing the National Economy

2. Why model the economy?
To understand causes of business cycles
and possible resolutions or fixes.
On one graph put inflation,
unemployment, GDP, and
economic growth

3. Aggregate Demand
Negative Slope:
As Price Level goes up:
Real Balance Effect
Feel Poorer
Interest Rate Effect
Need to borrow more
consumption borrowing, i rates,
Investment borrowing
Open Economy Effect
Go to exports

4. Aggregate Demand
Shifters:
Consumers:
Expectations
Income
Taxes orTransfers
Wages orWealth
Businesses
Investment
Interest Rates
Taxes
Government Spending
Net Exports
International Income/Expectations
Tariffs
Dollar strength

5. Aggregate Supply
Positive Slope:
As Price Level goes up
Profit Illusion
As prices go up,wages
and input costs stay fixed.
Inventory Effect
If below full capacity can
sell from inventory with no
cost pressures

6. Aggregate Supply
Shifters:
Change in input prices
wages, oil, etc.
Technology
Regulations
Change in input quality

7. Together:
Unemployment will increase as Y decreases and
Unemployment will decrease as Y increases.

8. AD Shock
Inventories
increase
Unemployment
increases
Prices fall
Wages fall
People feel richer
buy more
Back to
equilibrium
….or not.

9. Aggregate Supply Debate
Keynsians Classical
Never at full employment
even in good times
Prices and wages sticky
Adjustment will not happen
Always at full employment
Prices and wages slippery
Adjustment will happen

10. Another look at the differences

11. Demand Shift with Keynsian
-Sticky
Wages
-Sticky
Prices
-Slow
recovery
-Stuck
belowY*

12. Demand shifts with Classical
-Wages and
PricesAdjust
-Restoring
the economy
back to full
output

13. Aggregate Supply Debate
Keynsians Classical
Never at full employment
even in good times
Prices and wages sticky
Need to push AD right
with government
Always at full employment
Prices and wages slippery
Need to stay out of way
and wait for wages/prices
to fall

14. Compromise AS Curve

15. Practice
Aggregate Demand
Aggregate Supply
Consumer Income or
expectations
Investment income or
expectations
Government Spending
Change in exports or
imports
Costs of Production
Technology or weather
Government Policy

16. Inflation Causes
Demand Pull Inflation Cost Push Inflation

17. Full Employment Long Run AS
Below Y* recessionary gap Above Y* inflationary gap
PL down, Y down, Unemp up PL up, Y up, Unemp down
Y*
LRAS

18. LRAS relates to PPF
Growth
Increases LRAS and
PPF

19. Practice
1.AD or AS
2.Shift Right or Left
3.Find new
equilibrium
4.Outcomes:
-Price Level?
-Output?
-Unemployment?
1.The personal income tax rate goes up by a
significant amount

20. Practice
1.AD or AS
2.Shift Right or Left
3.Find new
equilibrium
4.Outcomes:
-Price Level?
-Output?
-Unemployment?
2.The stock market falls to record low levels
following remarks by the Fed Chairman
that “it is all just irrational exuberance”

21. Practice
1.AD or AS
2.Shift Right or Left
3.Find new
equilibrium
4.Outcomes:
-Price Level?
-Output?
-Unemployment?
3.A new computer program reads your
mind and automatically prepares word
documents dramatically increasing
productivity.

22. Practice
1.AD or AS
2.Shift Right or Left
3.Find new
equilibrium
4.Outcomes:
-Price Level?
-Output?
-Unemployment?
4. Nationwide the minimum wage goes to
$20 with retirement contributions.

23. Practice
1.AD or AS
2.Shift Right or Left
3.Find new
equilibrium
4.Outcomes:
-Price Level?
-Output?
-Unemployment?
5. The European union dissolves.The
ensuing uncertainty throws the entire
continent into a recession.

24. Practice
1.AD or AS
2.Shift Right or Left
3.Find new
equilibrium
4.Outcomes:
-Price Level?
-Output?
-Unemployment?
6. A La Nina weather system causes massive
droughts through out the US severely
reducing crop production, livestock health
and even the snow pack for ski resorts.

25. Practice
1.AD or AS
2.Shift Right or Left
3.Find new
equilibrium
4.Outcomes:
-Price Level?
-Output?
-Unemployment?
7. Congress passes tax cuts for firms that
expand jobs by 10%.

26. Practice
1.AD or AS
2.Shift Right or Left
3.Find new
equilibrium
4.Outcomes:
-Price Level?
-Output?
-Unemployment?
8. With increased pressure to fight crime,
states significantly tighten their sentencing
laws and increase their prison budgets.

27. Practice
1.AD or AS
2.Shift Right or Left
3.Find new
equilibrium
4.Outcomes:
-Price Level?
-Output?
-Unemployment?
9. A major earthquake and tsunami in China
disrupts supply chains across the world.

28. Practice
1.AD or AS
2.Shift Right or Left
3.Find new
equilibrium
4.Outcomes:
-Price Level?
-Output?
-Unemployment?
10. Following the building of a wall Canada
and Mexico leave NATO and form their
own trading bloc excluding the US.

29. Effects on AD of Deflation
If consumers expect prices to keep falling, they may hold off
on purchases today.
Value of debt rises, causing C & I confidence to fall
Cost of borrowing increases, as
paying back $ that are worth more
than those borrowed.
If input costs are locked up, profits fall

30. Costs of Recessionary Gap
Unemployment, Loss Production, Loss tax revenue
Long-term:
Loss of relevant skills
for job seekers –
Permanently unemployed
Business failures
Decreased investment
Lost government
programs, higher deficits
Shifts LRAS to the left

31. Phillips Curve
Limitations
Worker
expectations
Only true for
AD shifts, not
supply shocks