1.
Aggregate Supply and Demand

2.
<ul><li>Defined: </li></ul><ul><li>Amounts of Real Output </li></ul><ul><li>Buyers Collectively Desire </li></ul><ul><li>At Each Possible Price Level </li></ul>AGGREGATE DEMAND <ul><li>Aggregate Demand Curve </li></ul><ul><li>Down Sloping Due To: </li></ul><ul><ul><li>Real-Balances Effect </li></ul></ul><ul><ul><li>Interest-Rate Effect </li></ul></ul><ul><ul><li>Foreign Purchases Effect </li></ul></ul>Graphically…

3.
Price level Real domestic output, GDP CHANGES IN AGGREGATE DEMAND AD 1 AD 2 Aggregate Demand Can Increase

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Price level Real domestic output, GDP CHANGES IN AGGREGATE DEMAND AD 1 AD 3 Aggregate Demand Can Increase … or Decrease

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DETERMINANTS OF AGGREGATE DEMAND Change in Consumer Spending <ul><li>Consumer Wealth </li></ul><ul><li>Consumer Expectations </li></ul><ul><li>Consumer Indebtedness </li></ul><ul><li>Taxes </li></ul>Change in Investment Spending <ul><li>Real Interest Rates </li></ul><ul><li>Expected Returns </li></ul><ul><ul><li>Expected Future Business Conditions </li></ul></ul><ul><ul><li>Technology </li></ul></ul><ul><ul><li>Degree of Excess Capacity </li></ul></ul><ul><ul><li>Business Taxes </li></ul></ul>

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DETERMINANTS OF AGGREGATE DEMAND Government Spending Net Export Spending <ul><li>National Income Abroad </li></ul><ul><li>Exchange Rates </li></ul>

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How to increase productivity

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<ul><li>Higher Price Levels Provide An Incentive to Produce More </li></ul><ul><li>Aggregate Supply Has Three Segments or Ranges: </li></ul><ul><ul><li>1 - Horizontal Range </li></ul></ul><ul><ul><li>2 - Intermediate (Upsloping) Range </li></ul></ul><ul><ul><li>3 - Vertical Range </li></ul></ul>AGGREGATE SUPPLY Defined: The amounts of real output that firms will produce at each possible price level

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3 Reasons For Downward Sloping AD Curve Real Money-balances E ffect – economy’s monetary wealth. If we buy a fixed bundle of goods & services (food/clothing/shelter), at lower prices, it now takes less money. Our accumulated savings balances [401k, CDs, bonds] will purchase more. AD Interest Rate Effect – lower interest rates increase investment and consumption. Foreign Purchase Effect – with lower U.S. prices, both Americans and foreigners buy more American goods. Market Basket PL 1 PL 2

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AGGREGATE SUPPLY Price level Real domestic output, GDP Q P Horizontal Range Upsloping or Intermediate Range Vertical Range

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AGGREGATE SUPPLY Price level Real domestic output, GDP Q P AS 3 AS 1 AS 2 Increase In Aggregate Supply Decrease In Aggregate Supply Changes in Aggregate Supply

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DETERMINANTS OF AGGREGATE SUPPLY Change in Input Prices <ul><li>Domestic Resource Availability </li></ul><ul><ul><li>Land </li></ul></ul><ul><ul><li>Labor </li></ul></ul><ul><ul><li>Capital </li></ul></ul><ul><ul><li>Entrepreneurial Ability </li></ul></ul><ul><li>Prices of Imported Goods </li></ul><ul><li>Market Power </li></ul>

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DETERMINANTS OF AGGREGATE SUPPLY Change in Productivity Change in Legal-Institutional Environment <ul><li>Business Taxes and Subsidies </li></ul><ul><li>Government Regulation </li></ul>Productivity = Real Output Input

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AGGREGATE SUPPLY Price level Real domestic output, GDP Q P Long Run AS LR Long-run Aggregate Supply Q f Full-Employment

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AGGREGATE SUPPLY Price level Real domestic output, GDP Q P Short Run AS Aggregate Supply Short-run Q f Full- Employment

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Price Level Real Domestic Output, GDP Q P AS AD 510 502 514 EQUILIBRIUM AND CHANGES IN EQUILIBRIUM 92 100 a b Equilibrium Real Output

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Price Level Real Domestic Output, GDP Q P AS AD 1 INCREASES IN AD: DEMAND-PULL INFLATION P 2 P 1 AD 2 Q f Q 1 Q 2

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Price Level Real Domestic Output, GDP Q P AS AD 1 DECREASES IN AD: RECESSION & CYCLICAL UNEMPLOYMENT P 1 AD 2 Q f Q 1 a c b

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<ul><li>Wage Contracts </li></ul><ul><li>Morale, Effort, and Productivity </li></ul><ul><ul><li>Efficiency Wages </li></ul></ul><ul><li>Minimum Wage </li></ul><ul><li>Menu Costs </li></ul><ul><li>Fear of Price Wars </li></ul>Why prices are downwardly inflexible

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Price Level Real Domestic Output, GDP Q P AS 1 AD 1 DECREASES IN AS: COST-PUSH INFLATION P 2 Q f Q 1 a b AS 2 P 1

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Price Level Real Domestic Output, GDP Q P AS 1 AD 1 INCREASES IN AS: FULL EMPLOYMENT P 1 Q 2 Q 1 a b AS 2 P 2 … With Price-Level Stability AD 2 P 3 Q 3 Any Questions?

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Coming soon... FISCAL POLICY Chapter 12