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13_14:Aggregate Supply and Aggregate Demand

13_14:Aggregate Supply and Aggregate Demand. What is the purpose of the aggregate supply-aggregate demand model? What determines aggregate supply and aggregate demand? This discussion follows nicely from the tutorial EIA

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13_14:Aggregate Supply and Aggregate Demand

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  1. 13_14:Aggregate Supply andAggregate Demand • What is the purpose of the aggregate supply-aggregate demand model? • What determines aggregate supply and aggregate demand? • This discussion follows nicely from the tutorial EIA • I have included many extra slides to minimize the notes you will have to take.

  2. The Aggregate Supply-Aggregate Demand Model • The purpose of this model is: • to help understand and predict fluctuations of real GDP around potential GDP • to understand and predict fluctuations in the price level • next slide is a copy taken from lecture 8

  3. Aggregate Supply • The aggregate quantity of goods and services supplied is the sum of the quantities of final goods and services produced by all firms in the economy (real GDP). • Aggregate supply is the relationship between the quantity of real GDP supplied and the price level.

  4. Aggregate Supply • The aggregate production function shows that the quantity of real GDP supplied is determined by the quantities of labor and capital and the state of technology.

  5. Aggregate Supply • Capital and technology are fixed at any point in time. • However, labor is not fixed. • Lower wages result in a greater quantity of labor demanded • Higher wages result in a greater quantity of labor supplied

  6. Aggregate Supply • Full Employment • Occurs at the wage rate that makes the quantity of labor demanded equal to the quantity of labor supplied

  7. Aggregate Supply • Natural Rate of Unemployment • The unemployment rate that exists at full employment • In 1997 it was about 5.5% • It is probably much lower (e.g. 4%) today.

  8. Aggregate Supply • Potential GDP is the quantity of real GDP supplied when unemployment is at its natural rate and there is full employment.

  9. Aggregate Supply • Long-Run Aggregate Supply • The macroeconomic long run is a time frame that is sufficiently long for forces that move real GDP toward potential GDP to have done their work so that full employment prevails.

  10. Aggregate Supply • Long-Run Aggregate Supply • The long-run aggregate supply curve is the relationship between the quantity of real GDP supplied and the price level in the long run when real GDP equals potential GDP.

  11. Long-Run Aggregate Supply 140 130 120 Price level (GDP deflator, 1992 = 100) 110 100 90 6.0 6.5 7.0 7.5 8.0 8.5 Real GDP (trillions of 1992 dollars)

  12. Long-Run Aggregate Supply LAS 140 130 120 Price level (GDP deflator, 1992 = 100) 110 100 Potential GDP 90 6.0 6.5 7.0 7.5 8.0 8.5 Real GDP (trillions of 1992 dollars)

  13. Two Time Frames for Aggregate Supply • We distinguish two time frames for aggregate supply: • Long-run aggregate supply • Short-run aggregate supply

  14. Aggregate Supply • Long-Run Aggregate Supply • Potential GDP is independent of the price level because the price level, wage rate, and other resource prices all change by the same percentage in the “long-run”.

  15. Aggregate Supply • Short-Run Aggregate Supply • The macroeconomic short run is a period during which real GDP has fallen below or risen above potential GDP. • The unemployment rate has risen above or fallen below the natural rate.

  16. Aggregate Supply • Short-Run Aggregate Supply • The short-run aggregate supply curve is the relationship between the quantity of real GDP supplied and the price level in the short run when the money wage rate, other resource prices, and potential GDP remain constant.

  17. Short-Run Aggregate Supply a 100 6.0 b 105 6.5 c 110 7.0 d 115 7.5 e 120 8.0 Price Level Real GDP (GDP deflator) (trillions of 1992 dollars)

  18. Short-Run Aggregate Supply LAS 140 130 120 Price level (GDP deflator, 1992 = 100) 110 100 90 6.0 6.5 7.0 7.5 8.0 8.5 Real GDP (trillions of 1992 dollars)

  19. Short-Run Aggregate Supply LAS 140 130 SAS 120 e Price level (GDP deflator, 1992 = 100) d 110 c b 100 a 90 6.0 6.5 7.0 7.5 8.0 8.5 Real GDP (trillions of 1992 dollars)

  20. Short-Run Aggregate Supply LAS 140 130 SAS 120 e Price level (GDP deflator, 1992 = 100) d 110 c b 100 a Real GDP below potential GDP Real GDP above potential GDP 90 6.0 6.5 7.0 7.5 8.0 8.5 Real GDP (trillions of 1992 dollars)

  21. Aggregate Supply • Movements Along the LAS and SAS Curves • When the price level rises, holding the money wage rate and other resource prices constant, the quantity of real GDP supplied increases and there is a movementalong the SAS curve.

  22. Movements Along The Aggregate Supply Curves LAS 140 130 SAS 120 Price level (GDP deflator, 1992 = 100) 110 100 90 6.0 7.0 8.0 Real GDP (trillions of 1992 dollars)

  23. Movements Along The Aggregate Supply Curves LAS 140 130 SAS 120 Price level (GDP deflator, 1992 = 100) 110 100 90 6.0 7.0 8.0 Real GDP (trillions of 1992 dollars)

  24. Movements Along The Aggregate Supply Curves LAS Price level rises and money wage rate rises by the same percentage 140 130 SAS 120 Price level (GDP deflator, 1992 = 100) 110 Price level rises and money wage rate is unchanged 100 90 6.0 7.0 8.0 Real GDP (trillions of 1992 dollars)

  25. Aggregate Supply • Changes in Aggregate Supply • Occurs when influences on production other than the price level change

  26. Aggregate Supply • Potential GDP changes as a result of: 1) Changes in the full-employment quantity of labor 2) Changes in the quantity of capital 3) Advances in technology

  27. A Change in Potential GDP LAS 140 130 SAS0 120 Price level (GDP deflator, 1992 = 100) 110 100 90 6.0 7.0 8.0 Real GDP (trillions of 1992 dollars)

  28. A Change in Potential GDP LAS0 LAS1 140 Increase in potential GDP 130 SAS0 120 SAS1 Price level (GDP deflator, 1992 = 100) 110 100 90 6.0 7.0 8.0 Real GDP (trillions of 1992 dollars)

  29. Aggregate Supply • Changes in the money wage rate changes short-run aggregate supply but does not change long-run aggregate supply.

  30. A Change in the Money Wage Rate LAS 140 130 SAS0 120 Price level (GDP deflator, 1992 = 100) 110 a 100 90 6.0 7.0 8.0 Real GDP (trillions of 1992 dollars)

  31. A Change in the Money Wage Rate LAS 140 SAS2 130 SAS0 120 b Price level (GDP deflator, 1992 = 100) 110 a 100 90 6.0 7.0 8.0 Real GDP (trillions of 1992 dollars)

  32. Aggregate Demand • The quantity of real GDP demanded is the sum of the real consumption expenditure (C), investment (I), government purchases (G), and exports (X) minus imports (M). Y = C + I + G + X – M

  33. Aggregate Demand • Aggregate demand is the relationship between the quantity of real GDP demanded and the general price level. • Important: The aggregate demand schedule is not a relationship based upon the relative prices of goods such as apples and pears.

  34. Aggregate Demand a' 90 8.0 b' 100 7.5 c' 110 7.0 d' 120 6.5 e' 130 6.0 Price Level Real GDP (GDP deflator) (trillions of 1992 dollars)

  35. Aggregate Demand 140 130 120 Price level (GDP deflator, 1992 = 100) 110 100 90 6.0 6.5 7.0 7.5 8.0 Real GDP (trillions of 1992 dollars)

  36. Aggregate Demand 140 e' 130 d' 120 Price level (GDP deflator, 1992 = 100) c' 110 b' 100 e' 90 AD 6.0 6.5 7.0 7.5 8.0 Real GDP (trillions of 1992 dollars)

  37. Aggregate Demand 140 e' 130 d' 120 Price level (GDP deflator, 1992 = 100) c' 110 b' 100 e' 90 AD 6.0 6.5 7.0 7.5 8.0 Real GDP (trillions of 1992 dollars)

  38. Aggregate Demand • The two reasons the demand curve sloped downward are: 1) Wealth effect • Changes in the price level, with other things remaining the same, change real wealth. • People try to restore wealth by increasing saving and decreasing consumption.

  39. Aggregate Demand • The two reasons the demand curve sloped downward are: 2) Substitution effects • People substitute future consumption for present consumption as a result of higher interest rates. • A change in prices cause consumers to spend less on domestic items and more on imported items.

  40. Aggregate Demand • Changes in the Quantity of Real GDP Demanded • When the price level changes, other things remaining the same, the quantity of real GDP demanded changes and there is movement along the aggregate demand curve.

  41. Aggregate Demand • Changes in Aggregate Demand • A change in any factor than influences buying plans other than the price level

  42. Aggregate Demand • The factors that influence buying plans other than the price level and bring a change in aggregate demand are: 1) Expectations 2) Fiscal policy and monetary policy 3) The world economy

  43. Aggregate Demand • Expectations • Expectations about future incomes, inflation and profits influence buying plans today.

  44. Aggregate Demand • Fiscal Policy and Monetary Policy • Fiscal policy is the government’s attempt to influence the economy by setting and changing taxes, transfer payments, and government purchases.

  45. Aggregate Demand • Fiscal Policy and Monetary Policy • These influence a household’s disposable income. • Disposable income equals aggregate income minus taxes plus transfer payments.

  46. Aggregate Demand • Fiscal Policy and Monetary Policy • Monetary policy consists of changes in interest rates and in the quantity of money in the economy.

  47. Aggregate Demand • The World Economy • The exchange rate and foreign income affect aggregate demand.

  48. Changes in Aggregate Demand 140 130 120 Price level (GDP deflator, 1992 = 100) 110 100 90 AD0 6.0 6.5 7.0 7.5 8.0 Real GDP (trillions of 1992 dollars)

  49. Changes in Aggregate Demand 140 Increase in aggregate demand 130 120 Price level (GDP deflator, 1992 = 100) 110 100 AD1 90 AD0 6.0 6.5 7.0 7.5 8.0 Real GDP (trillions of 1992 dollars)

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