06 aggregate demand and supply

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06 aggregate demand and supply

  1. 1. Chapter 20Aggregate Demand and Supply • Key Concepts • Summary • Practice Quiz • Internet Exercises 1
  2. 2. In this chapter, you will learn to solve these economic puzzles: Why does the Was Johngreenhouse Maynard Would the prescription Keynes’s inflation, aggregate supply effect causeGreat curvethe three for have unemployment,right? or both? Depression different segments? 2
  3. 3. What is the Aggregate Demand Curve?The curve shows the level of real GDP purchased by households, businesses, government, and foreigners at different price levels during a time period, ceteris paribus 3
  4. 4. What does the Horizontal Axis measure?The value of final goods and services included in real GDP measured in base year dollars 4
  5. 5. What does the Vertical Axis measure?It is an index of the overall price level, such as the GDP deflator or the CPI 5
  6. 6. Why does the Aggregate Demand Curve slopedownward to the right?• Real balance wealth effect• Interest rate effect• Net exports effect 6
  7. 7. What is the Real Balance Effect?Consumers spend more on goods and services because lower prices make their dollars more valuable 7
  8. 8. What is the Interest Rate Effect?Assuming fixed credit, an increase in the price level translates through higher interest rates into a lower real GDP 8
  9. 9. What is the Net Exports Effect?A higher domestic price level makes U.S. goods more expensive compared to foreign goods, exports decrease, imports increase, decreasing real GDP 9
  10. 10. The Aggregate Demand Curve$200 Price Level$150 A B$100 AD $50 Real GDP 2 4 6 8 10 12 10
  11. 11. What can cause a shift in the Aggregate Demand Curve?Consumption, investments, government spending and net exports can change 11
  12. 12. A Shift in the Aggregate Demand Curve200 Price Level (CPI)150 A B100 50 AD2 Real GDP AD1 2 4 6 8 10 12 12
  13. 13. What is theAggregate Supply Curve? The curve that shows the level of real GDP produced at different price levels during a time period, ceteris paribus 13
  14. 14. Why did Keynesassume fixed product prices and wages?During a deep recession or depression, there are many idle resources in the economy 14
  15. 15. Why do idle Resources mean Fixed Prices?Producers are willing to sell additional output at current prices because there is plenty of resources to go around for everyone who wants them 15
  16. 16. Why do idle Resources mean Fixed Wages?The supply of unemployed workers willing to work for the prevailing wage rate diminishes the power of workers to increase their wages 16
  17. 17. What kind of Supply Curve would explainFixed Prices and Wages? A horizontal supply curve 17
  18. 18. The Keynesian Horizontal Aggregate Supply Curve200 Price Level (CPI)150 E1 E2100 AS 50 AD2 Real GDP AD1 2 4 6 8 10 12 18
  19. 19. Price level remains constant, while real GDP and employment rise Aggregate demand increases and the economy moves from E1 to E2Governmentspending (G) increases 19
  20. 20. According to Keynes, what will a shift inAggregate Demand do? It will restore a depressed economy to full employment 20
  21. 21. The Keynesian Horizontal Aggregate Supply Curve200 Price Level (CPI) Full employment150 E1 E2100 AS 50 AD2 Real GDP AD1 2 4 6 8 10 12 21
  22. 22. What is the Classical view of the Aggregate Supply Curve?It is a vertical line at the full employment output 22
  23. 23. According to the Classical Economists,where does the economy normally operate? The economy normally operates at its full employment level 23
  24. 24. How do the Classical Economists view Prices and Costs?The price level of products and production costs change by the same percentage in order to maintain full employment 24
  25. 25. The Classical Aggregate Supply Curve Surplus AS200 Price Level (CPI) Full employment E1150 E100  E2 50 AD1 Real GDP AD2 2 4 6 8 10 12 14 16 17 25
  26. 26. Three Ranges of the Aggregate Supply Curve AS Classical RangePrice Level Full Employment Intermediate Range Keynesian Range Real GDP YK YF 26
  27. 27. Increasing Demand Price Level AS200150 AD6100 AD5 Full Employment AD4 50 AD2 AD3 Real GDP AD1 0 2 4 6 8 10 12 27
  28. 28. What factors can cause a shift in theAggregate Supply Curve? A change in ~ • resource prices • technology • taxes • subsidies • regulations 28
  29. 29. A Rightward Shift in the AS1 Aggregate Supply Curve200 E1 AS2150 E2 Price Level Full employment100 AD 50 Real GDP 2 4 6 8 10 12 14 16 17 29
  30. 30. Increase in the aggregate supply curveChange in one or more nonprice- level determinants: resource prices, technological change,taxes, subsidies, and regulations 30
  31. 31. What are the twotypes of Inflation? • Cost push • Demand pull 31
  32. 32. What isCost Push Inflation?A rise in the general price level resulting from an increase in the cost of production 32
  33. 33. Cost Push Inflation AS2200 Price Level AS1150 E2 Full employment100 E1 AD 50 Real GDP 2 4 6 8 10 12 14 16 17 33
  34. 34. What isDemand Pull Inflation?A rise in the general price level resulting from an excess of total spending 34
  35. 35. Demand Pull Inflation200 Price Level AS150 Full employment E2100 E1 AD2 50 AD1 Real GDP 2 4 6 8 10 12 14 16 17 35
  36. 36. What determines the Business Cycle?Shifts in the aggregate demand and aggregate supply curves 36
  37. 37. Key Concepts 37
  38. 38. Key Concepts• What is the Aggregate Demand Curve?• Why does the Aggregate Demand Curve slope d• What can cause a shift in the Aggregate Deman• What is the Aggregate Supply Curve?• Why did Keynes assume fixed product prices an• What kind of Supply Curve would explain Fixe 38
  39. 39. Key Concepts cont.• According to Keynes, what will a shift in Aggre• What is the Classical view of the Aggregate Su• According to the Classical Economists, where d• What factors can cause a shift in the Aggregate• What are the two types of Inflation? 39
  40. 40. Summary 40
  41. 41. The aggregate demand curveshows the level of real GDP purchasedin the economy at different price levelsduring a period of time. 41
  42. 42. Reasons why the aggregatedemand curve is downward-slopinginclude the following three effects: 42
  43. 43. (1) The real balances or wealtheffect is the impact on real GDPcaused by the inverse relationshipbetween the purchasing power offixed value financial assets andinflation, which causes a shift in theconsumption schedule. 43
  44. 44. (2) The interest-rate effectassumes a fixed money supply, and,therefore, inflation increases thedemand for money. As the demandfor money increases, the interestrate rises, causing consumption andinvestment spending to fall. 44
  45. 45. (3) The net exports effect is theimpact on real GDP caused by theinverse relationship between netexports and inflation. An increase inthe U.S. price level tends to reduceU.S. exports and increase imports,and vice versa. 45
  46. 46. A Shift in the Aggregate Demand Curve200 Price Level (CPI)150 A B100 50 AD2 Real GDP AD1 2 4 6 8 10 12 46
  47. 47. The aggregate supply curveshows the level of real GDP that theeconomy will produce at differentpossible price levels. The shape ofthe aggregate supply curve dependson the flexibility of prices andwages as real GDP expands andcontracts. The aggregate supplycurve has three ranges: 47
  48. 48. (1) The Keynesian range of thecurve is horizontal because neitherthe price level nor production costswill increase when there issubstantial unemployment in theeconomy. 48
  49. 49. (2) In the intermediate range,both prices and costs rise as realGDP rises toward full employment.Prices and production costs risebecause of bottlenecks, the strongerbargaining power of labor, and theutilization of less productiveworkers and capital 49
  50. 50. (3) The classical range is thevertical segment of the aggregatesupply curve. It coincides with thefull-employment output. Becauseoutput is at its maximum, increasesin aggregate demand will only causea rise in the price level. 50
  51. 51. Three Ranges of the Aggregate Supply Curve AS Classical RangePrice Level Full Employment Intermediate Range Keynesian Range Real GDP YK YF 51
  52. 52. Aggregate demand and aggregatesupply analysis determines theequilibrium price level and theequilibrium real GDP by theintersection of the aggregate demandand the aggregate supply curves. Inmacroeconomic equilibrium,businesses neither overestimate norunderestimate the real GDP demandedat the prevailing price level. 52
  53. 53. Stagflation exists when aneconomy experiences inflation andunemployment simultaneously.Holding aggregate demand constant,a decrease in aggregate supplyresults in the unhealthy condition ofa rise in the price level and a fall inreal GDP and employment. 53
  54. 54. Cost-push inflation is inflationthat results from a decrease in theaggregate supply curve while theaggregate demand curve remainsfixed. Cost-push inflation isundesirable because it isaccompanied by declines in bothreal GDP and employment. 54
  55. 55. Cost Push Inflation AS2200 Price Level AS1150 E2 Full employment100 E1 AD 50 Real GDP 2 4 6 8 10 12 14 16 17 55
  56. 56. Demand-pull inflation isinflation that results from anincrease in the aggregate demandcurve in both the classical and theintermediate ranges of the aggregatesupply curve while the aggregatesupply curve is fixed. 56
  57. 57. Demand Pull Inflation200 Price Level AS150 Full employment E2100 E1 AD2 50 AD1 Real GDP 2 4 6 8 10 12 14 16 17 57
  58. 58. Chapter 20 Quiz ©2000 South-Western College Publishing 58
  59. 59. 1. The aggregate demand curve is defined as a. the net national product. b. the sum of wages, rent, interest, and profits. c. the real GDP purchased at different possible price levels. d. the total dollar value of household expectations.C. Answers a, b, and c are not real GDP purchases at different possible price levels during a time period. 59
  60. 60. 2. When the supply of credit is fixed, an increase in the price level stimulates the demand for credit, which, in turn, reduces consumption and investment spending. This effect is called the a. real balance effect. b. interest-rate effect. c. net exports effect. d. substitution effect. B. At a high price level, the demand for borrowed money increases and results in higher cost of borrowing (interest rates). Higher interest rates result in lower consumption and investment spending. 60
  61. 61. 3. The real balance effect occurs because a higher price level reduces the real value of people’s a. financial assets. b. wages. c. unpaid debt. d. physical investments.A. As price increase the dollars people receive in their paychecks and wealth are worth less. As a result, real GDP demand decreases. 61
  62. 62. 4. The net exports effect is the inverse relationship between net exports and the _______of an economy. a. Real GDP. b. GDP deflator. c. Price level. d. Consumption spending.C. A higher domestic price level makes U.S. goods more expensive relative to foreign goods and vice versa. 62
  63. 63. 5. Which of the following will shift the aggregate demand curve to the left? a. An increase in exports. b. An increase in investment. c. An increase in government spending. d. A decrease in government spending.D. Answers a, b, c shift the aggregate demand curve to the right. 63
  64. 64. 6. Which of the following will not shift the aggregate demand curve to the left? a. Consumers become more optimistic about the future. b. Government spending decreases. c. Business optimism decreases. d. Consumers become pessimistic about the future. A. Answers b, c and d shift the aggregate demand curve leftward. 64
  65. 65. 7. The popular theory prior to the Great Depression that the economy will automatically adjust to achieve full employment is a. supply-side economics. b. Keynesian economics. c. classical economics. C.d.Supply-side economic concerns shifts in mercantilism. aggregate supply. Keynesians do not believe the economy automatically adjusts to full employment. Mercantilism is the idea that gold or silver is the source of a nation’s wealth. 65
  66. 66. 8. Classical economists believed that the a. price system was stable. b. goal of full employment was impossible. c. price system automatically adjusts the economy to full employment in the long run. d. government should not attempt to restore full employment. C. This is a key assumption for the vertical shape of the classical aggregate supply curve. 66
  67. 67. 9. Which of the following is not a range on the eclectic or general view of the aggregate supply curve? a. Classical range. b. Keynesian range. c. Intermediate range. d. Monetary range. D. Answers a, b, and c are the three district ranges of the aggregate supply at a level of real GDP below full employment. 67
  68. 68. Three Ranges of the Aggregate Supply Curve AS Classical RangePrice Level Full Employment Intermediate Range Keynesian Range Real GDP YK YF 68
  69. 69. 10. Macroeconomic equilibrium occurs when a. aggregate supply exceeds aggregate demand. b. the economy is at full employment. c. aggregate demand equals aggregate supply. d. aggregate demand equals the average price level. C. Note that aggregate demand can equal aggregate supply at a level of real GDP below full employment. 69
  70. 70. 11. Along the classical or vertical range of the aggregate supply curve, a decrease in the aggregate demand curve will decrease a. both the price level and real GDP. b. only real GDP. c. only the price level. d. neither real GDP or the price level.C. Along the vertical range of the aggregate supply curve, the economy is at full employment and only the price level changes. 70
  71. 71. 12. Other factors held constant, a decrease in resource prices will shift the aggregate a. demand curve leftward. b. demand curve rightward. c. supply curve leftward. d. supply curve rightward.D. Changes in production costs do not affect the aggregate demand curve. 71
  72. 72. 13. Assuming a fixed aggregate demand curve, a leftward shift in the aggregate supply curve causes a (an) a. increase in the price level and a decrease in real GDP. b. increase in the price level and an increase in real GDP. c. decrease in the price level and a decrease in real GDP. d. decrease in the price level and an increase in real GDP. A. 72
  73. 73. Cost Push Inflation AS2200 Price Level AS1150 E2 Full employment100 E1 AD 50 Real GDP 2 4 6 8 10 12 14 16 17 73
  74. 74. 14. An increase in the price level caused by a rightward shift of the aggregate demand curve is called a. cost-push inflation. b. supply shock inflation. c. demand shock inflation. d. demand-pull inflation. D. 74
  75. 75. Demand Pull Inflation200 Price Level AS150 Full employment E2100 E1 AD2 50 AD1 Real GDP 2 4 6 8 10 12 14 16 17 75
  76. 76. 15. Suppose workers become pessimistic about their future employment, which causes them to save more and spend less. If the economy is on the intermediate range of the aggregate supply curve, then a. both real GDP and the price level will fall. b. real GDP will fall and the price level will rise. c. real GDP will rise and the price level will fall. d. both real GDP and the price level will rise. A. A leftward movement of the aggregate demand curve along a downward sloping aggregate supply curve will result in lower prices and less employment. 76
  77. 77. Internet ExercisesClick on the picture of the book, choose updates by chapter for the latest internet exercises 77
  78. 78. END 78

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