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TCO 5

TCO 5. Given aggregate demand and supply curves, and a change in one of the determinants of aggregate demand and supply, evaluate the possibilities of inflation or recession in the given circumstances. Define aggregate supply (AS) and aggregate demand (AD).

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TCO 5

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  1. TCO 5 Given aggregate demand and supply curves, and a change in one of the determinants of aggregate demand and supply, evaluate the possibilities of inflation or recession in the given circumstances. Define aggregate supply (AS) and aggregate demand (AD). Explain how the economy reaches a macroeconomic equilibrium. Explain potential GDP. Compare and contrast the classical view and the Keynesian view of the determination of output, employment, and the price level.

  2. Aggregate Demand and Aggregate Supply

  3. Objectives • Relate GDP to price level and show how equilibrium price level and GDP are determined • Why AD curves slope downward and SR AS curves slope upward • Why LR AS curves are vertical

  4. Aggregate Demand: the start

  5. Aggregate Demand = Consumption Government Spending on Goods and Services Gross Investment Net Exports Expenditure Approach to GDP on Circle of Income

  6. Consumption • Disposable Income • Cost & availability of credit • Expectations • Population Size [age, etc.]

  7. Gross Investment • Interest rates • Government policy • Expectations

  8. Government • Politics • Current State of Economy

  9. Net Exports • Trade Policy • Do later with International—includes tariffs and treaties • Exchange Rate • Do later • Politics

  10. Question 1 Aggregate Demand is made up of spending by: a. Consumers b. Government Spending on Goods and Services c. Businesses d. Government Spending on Transfer Payments

  11. Question 2: Which category of spending was left out of the last question? a. Consumption b. Government Spending on Goods and Services c. Investment d. Net Exports

  12. Question 3: The Aggregate Demand curve slopes downward for all of the following reasons except: A. It is a demand curve. B. It shows an inverse relationship between the price level and the quantity-demanded [GDP] C. It shows that as the price level increases, Aggregate Demand [GDP] increases. D. It shows that as the price level increases, the quantity-demanded [GDP] decreases.

  13. Question 4: If the price level increases, then Aggregate Demand A. Shifts upward to the right, showing an increase. B. Shifts downward to the left showing a decrease. C. Stays the same, showing no change. D. Shows a movement along the Aggregate Demand Curve to the right, showing an increase.

  14. What happens when Price Level Changes • Direct Effect [Real-Balance Effect/Wealth Effect] • PL increases = decrease in purchasing power of money so Consumption falls • PL decreases = increase in purchasing power of money so Consumption rises • Indirect Effect [Interest Rate Effect] • PL increases = nominal interest rates rise as demand for money rises so Consumption falls • PL decreases = nominal interest rates fall as demand for money falls so Consumption rises • Open Economy Effect [International Trade Effect] • PL increases = US goods expensive so buy foreign • PL decreases = US goods cheap so buy American Causes Movement Along AD.

  15. Nonprice Level Determinants of AD • Government Spending & Tax • Increase Spending = increase AD • Increase Tax = decrease AD • Expectations • People optimistic about economy = increase AD • People pessimistic about economy = decrease AD • Money • Increase amount of money in circulation = increase AD • Decrease amount of money in circulation = decrease AD • Population • Increase population = increase AD • Decrease population = decrease AD • Foreign Income and Prices • Foreign Prices increase = increase in AD • Foreign Prices decrease = decrease in AD • Foreign Incomes increase = increase in AD • Foreign Incomes decrease = decrease in AD Causes AD curve itself to shift.

  16. Question 5: All of the following will cause the whole Aggregate Demand Curve to shift except: A. An increase in Government Spending B. People thinking the economy is in bad shape. C. A decrease in the population. D. An increase in the Price Level.

  17. Question 6: Greenspan increased the Federal Funds Rate in hope that which of the following would happen? A. Aggregate Demand would increase. B. Aggregate Demand would show a movement along the curve to the right. C. Aggregate Demand would show a movement along the curve to the left. D. Aggregate Demand would decrease.

  18. SR Aggregate Supply start

  19. Aggregate Supply = Wages Rent Interest Profits Indirect Business Tax Depreciation Income Approach to GDP on Circle of Income

  20. Question 7: Aggregate Supply is comprised on all of the following except: A. Wages B. Indirect Business Taxes C. Government Spending on Goods and Services D. Profits

  21. Determinants • Production costs • Current production capacity and investment plans • Technology • Productivity • Human capital • Expectations • Government Policies

  22. Question 8: If the Price Level increases, the Short Run Aggregate Supply Curve will A. Shift to the right, showing an increase B. Shift to the left, showing a decrease C. Show a movement along the curve to the left, showing a decrease D. Stay the same.

  23. Expanding Output in Short Run: Upward slope • Use Labor More Intensively • Workers work harder • Longer workday • Work more days • Move workers into production that counts in GDP • Use Capital Goods More Intensively • Run machines longer • Run machines faster • Reduce maintenance to reduce down time of machines • Employ More workers • Fewer people out of work for shorter periods of time • Bring in people previously not in labor force Causes movement along SRAS curve.

  24. Question 9: A nation can increase output in the Short Run without causing the SR Aggregate Supply curve to increase because it can do all the following except: A. Have workers work longer hours and work harder B. Work machines for longer hours and shut down less. C. Hire retired workers D. Suddenly discover a vast new oil deposit under Antarctica

  25. When capacity is reached? • Workers less willing to work longer and harder • Machines must be shut down for maintenance • Harder to find workers at existing wage--want more workers must pay more

  26. LR Aggregate Supply start

  27. Why is the Long Run AS Vertical? • Technology does not change • If technology constant, LRAS vertical • Endowments of resources are fixed • If an economy is using all of its resources, LRAS vertical • If the resource quality not changed, LRAS vertical • Labor Productivity unchanged • No increase in productivity, LRAS vertical • Population is constant • No population growth, LRAS vertical. • Full adjustment to Price Level Changes • Price level changes have no effect on LRAS because over time as Price level increases, supply prices increase so supply stays the same.

  28. What shifts both the SRAS and LRAS curves? • Changes in resource endowments • increase in resources, increase both curves • decrease in resources, decrease both curves • Changes in technology or knowledge • increase technology or knowledge, increase both curves • decrease technology or knowledge, decrease both curves

  29. Question 10: Both the LRAS and the SRAS will shift as a result of A. A change in the price level B. A change in the level of technology C. A change in Government spending D. A change in the amount of money in the economy.

  30. What effects ONLY the SRAS? • Temporary Changes in Input Prices • Increase input prices, ceteris paribus, decreases SRAS • Decrease input prices, ceteris paribus, increases SRAS Causes a movement along the curve.

  31. AD = AS

  32. Question 11: What happens to equilibrium if AD increases? A. Price level increases B. SRAS responds by working resources harder--movement to the right along the curve C. LRAS shifts to the right, increases D. LRAS no longer in equilibrium with SRAS and AD

  33. What about unanticipated changes to the economy: War in Iraq? • Increased Government spending = increase in AD • Increase in AD can cause an increase in the Price Level = inflation • This causes the AD curve to cross the SRAS curve at a larger GDP and a higher Price Level • LRAS is no longer in equilibrium with the others • If this is a short war, AD curve decreases due to reduced Government spending and SRAS and the new AD curve reach equilibrium at a lower GDP and lower Price Level. • If the war is long, SRAS will increase due to new technology, etc. and the LRAS will also increase. • Depending on the speed of the changes and the size of the shifts • AD, SRAS and LRAS could reach equilibrium at the old Price Level but a higher GDP • AD, SRAS and LRAS could reach equilibrium at a higher Price Level and GDP

  34. What if the war is fought IN the US? • What happens to SRAS and LRAS? • What happens to AD? • Hint: What happened to the states of the Confederacy during the Civil War?

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