Aggregate Demand and Aggregate Supply
12
McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Aggregate Demand
• Real GDP desired at each price level • Inverse relationship
• Real balances effect • Interest effect • Foreign purchases effect
LO1 12-2
Aggregate Demand
Real domestic output, GDP
Pric
e le
vel
AD
LO1
0
12-3
Changes in Aggregate Demand
• Determinants of aggregate demand • Shift factors affecting C, I, G, Xn
• 2 components involved • Change in one of the determinants • Multiplier effect
LO1 12-4
Changes in Aggregate Demand
Real domestic output, GDP
Pric
e le
vel
AD1 AD3
AD2
LO1
0
12-5
Consumer Spending
• Consumer wealth • Household borrowing • Consumer expectations • Personal taxes
LO1 12-6
Investment Spending
• Real interest rates • Expected returns
• Expectations about future business conditions
• Technology • Degree of excess capacity • Business taxes
LO1 12-7
Government Spending
• Government spending increases • Aggregate demand increases (as
long as interest rates and tax rates do not change)
• More transportation projects • Government spending decreases
• Aggregate demand decreases • Less military spending
LO1 12-8
Net Export Spending
• National income abroad • Exchange rates
• Dollar depreciation • Dollar appreciation
LO1 12-9
Aggregate Supply
• Total real output produced at each price level
• Relationship depends on time horizon • Immediate short run • Short run • Long run
LO2 12-10
AS: Immediate Short Run
Real domestic output, GDP
Pric
e le
vel
ASISR
Qf
Immediate-short-run aggregate supply
P1
0
LO2 12-11
Aggregate Supply: Short Run
Real domestic output, GDP
Pric
e le
vel
0 Qf
AS
Aggregate supply (short run)
LO2 12-12
Aggregate Supply: Long Run
Real domestic output, GDP
Pric
e le
vel
ASLR
Qf 0
Long-run aggregate supply
LO2 12-13
Changes in Aggregate Supply
• Determinants of aggregate supply • Shift factors
• Collectively position the AS curve • Changes raise or lower per-unit
production costs
LO2 12-14
Changes in Aggregate Supply
Real domestic output, GDP
Pric
e le
vel
AS1 AS3
AS2
0
LO2 12-15
Input Prices
• Domestic resource prices • Labor • Capital • Land
• Prices of imported resources • Imported oil • Exchange rates
LO2 12-16
Productivity
• Real output per unit of input • Increases in productivity reduce
costs • Decreases in productivity increase
costs
LO2
Per-unit production cost = total input cost total output
Productivity = total output total inputs
12-17
Legal-Institutional Environment
• Legal changes alter per-unit costs of output • Taxes and subsidies • Extent of government regulation
LO2 12-18
Equilibrium
Real domestic output, GDP (billions of dollars)
Pric
e le
vel (
inde
x nu
mbe
rs)
100
92
502 510 514
a b
AD
AS Real Output Demanded (Billions)
Price Level (Index Number)
Real Output Supplied (Billions)
$506 108 $513 508 104 512 510 100 510 512 96 507 514 92 502
0
LO3 12-19
AD Increases: Demand-Pull Inflation
Real domestic output, GDP
Pric
e le
vel
AD1
AS
P1
P2
Q2 Q1 Qf
AD2
0
LO4 12-20
Decreases in AD: Recession
Real domestic output, GDP
Pric
e le
vel
AD1
AS
P1
P2
Q1 Q2 Qf
AD2
c a
b
0
LO4 12-21
Decreases in AD: Recession
• Prices are downwardly inflexible • Fear of price wars • Menu costs • Wage contracts • Efficiency wages • Minimum wage law
LO4 12-22
Decreases in AS: Cost-Push Inflation
Real domestic output, GDP
Pric
e le
vel
AD
AS1
P1
P2
Q1 Qf
AS2
a
b
0
LO4 12-23
Increases in AS: Full-Employment
Real domestic output, GDP
Pric
e le
vel
AD1
AS2
P1
P2
Q2 Q1
AS1
b
AD2
c P3
Q3
a
0
LO4 12-24
Impact of Oil Prices Diminished?
• 1970’s • Reduced AS and negative GDP gap • Cost-push inflation • Rising unemployment
• 2000’s • Core inflation steady • Use 50% less oil and gas today • Federal Reserve more vigilant
12-25
Stagflation is a combination of
recession (falling real GDP) and inflation. Now
we will show how stagflation could be
produced by a supply shock
Inflation-Unemployment pairs for the U.S., 1960-89
Unemployment Rate
109876543
Infla
tion
Rat
e
16
14
12
10
8
6
4
2
0
8988
87
86
8584
83
82
81
80
79
78
7776
75
74
73
72
71
7069
68
6766
6564
636261
60
www.bls.gov
Price per barrel of 320 crude oil Date Price ($)
Jan. 1972 1.79Dec. 1973 4.68Jan. 1974 10.84
April 1979 14.55June 1979 18.00Nov 1979 24.00Aug. 1980 30.00Oct. 1981 34.00
Source: Petroleum Economist
• Anchovies • Grain failures
Stagflation due to oil price shock
10.0 9.75
AS0
AD
AS1
110
115
Real GDP 0
Price Level Story of Joseph Buffer Stock
program