Macroeconomics

Lecture 19

Aggregate Demand Aggregate Supply

Model

Questions

Key Termsrecessiondepressionnatural rate of outputstagflation

Economic Cycle

Fluctuations

Economic Cycle

AD-AS Model

Aggregate Demand and

Aggregate Supply

Recession

A period of declining real incomes and rising

unemployment defined as negative growth for two quarters (six months)

Depression

Severe recession

Three Key FactsIrregular and Unpredictable

Variables fluctuate together

Output falls - Unemployment increases

VariablesGDP

Financial SystemInterest Rates

UnemploymentMonetary System

Trade Balance

Real - QuantitiesNominal - Money

Nominal - always one dollar - fixed

Real - what it will buy - varies

Can you have a nominal change but not a real change?

Price level changes but output stays the same

Real - Quantity

Nominal - Price

Classical ViewReal qualities matter

Amount of money does not matter

New ViewReal qualities interact with

nominal money

Long Run and Short Run

Good in the short runBad in the long run

Bad in the short runGood in the long run

Lag

Time between cause and effect

PriceLevel

Quantity of Output

Equilibriumpricelevel

Equilibriumoutput

AD- AS Model

Aggregate Demand

AggregateSupply

PriceLevel

Quantity of Output

Why does the demand curve slope downward?

PriceLevel

Quantity of Output

Y1

Aggregate Demand

Y2

P1

P2

1. real wealth increases

2. interest rates fall

3. exchange rates depreciate

increase spending

increase investments

increase exports

Price LevelConsumption - Wealth Effect

Investment - Interest-Rate Effect

Net Exports - Exchange-Rate Effect

Wealth EffectLower prices

Buy more stuff

Increase output

Higher prices

Buy less stuff

Decrease output

Lower prices

Need less money

More money to loan

Lower rates

Borrow easy

Buy more stuff

Increase output

Interest Rate EffectHigher prices

Need more money

Less money to loan

Higher rates

Borrow harder

Buy less stuff

Decrease output

Exchange-Rate EffectLower prices

Cause interest rates to decline

Causes currency to depreciate

Stimulates demand for local currency

Stimulates exports

Increases local output

Higher prices

Cause interest rates to increase

Causes currency to appreciate

Stimulates demand for foreign currency

Stimulates imports

Decreases local output

PriceLevel

Quantity of Output

Demand Shiftchange in consumptionchange in investmentgovernment purchasesnet exports

PriceLevel

Quantity of Output

P1

AD- AS Model

Aggregate Demand

Short RunAggregateSupply

Y1 Y2

P2

Long RunAggregateSupply

P3

Quiz 11. Name three reasons why the Aggregate-Demand Curve slopes downward.

2. Name four reasons why the Aggregate-Demand Curve shifts

Wealth, Interest Rate, Exchange Rate

Consumption, Investment, Government, Net Exports (C + I + G + NX)

Aggregate Demand CurveSlopes Downward

Wealth Interest Rate

Exchange Rate

ShiftsConsumptionInvestment

GovernmentNet Exports

Aggregate Supply Curve

Two Curves

Short Run

Long Run

Two Supply Curves

Short RunLong Run

Short Run

Adrenaline

Give 110%

Push to exceed normal capacity

Long Run

Run out of Adrenaline

Fall back to normal

Cannot do 110% forever

unless.....

Long Run Supply Curve New Capital

Human

Physical

Intellectual

Financial

Cultural

PriceLevel

Real GDP or Y

AD- AS Model

Aggregate Demand

Short RunAggregateSupply

Long RunAggregateSupply

LRASShape - Vertical Capacity fixedShift Physical Financial Human Intellectual Cultural

SRASShape - Slope Up Sticky Wages Sticky Prices MisperceptionsShift Physical Financial Human Intellectual Cultural Expectations

ADShape - Slope Down Wealth Effect Interest Effect Exchange EffectShift Consumption Investment Government Net Exports

PriceLevel

Quantity of Output

Two Supply Curves

Short-RunAggregateSupply

Long-RunAggregateSupply

Price changedoes not affect the quantity of goods and services

P

New CapitalHumanPhysicalIntellectualFinancial Cultural

PriceLevel

Quantity of Output

Two Supply Curves

LRAS1

Y1

LRAS2

Y3

LRAS3

Y3

New CapitalHumanPhysicalIntellectualFinancial Cultural

PriceLevel

Quantity of Output

Two Supply Curves

LRAS1

Y1

LRAS2

Y3

LRAS3

Y3

P1

P2

P3

1. Name three reasons why the Short-Run Aggregate-Supply Curve slopes upward.

2. Name six reasons why the Short-Run Aggregate-Supply Curve shifts

Sticky Wage, Sticky Price, Misperceptions

Capital (5 things) and Expected Price Level

Quiz

4 Step Analysis1. Decide what curve the event affects.

2. Decide direction of the shift

3. Diagram impact

4. Analyze short-run to long-run

Stagflation

A period of falling output and rising prices

Remember1. Three curves: AD, SRAS, LRAS

2. Event can affect one or more of the curves

3. Determine which curve and which direction.

4. Diagram impact