Transcript Mr. Mayer AP Macroeconomics

Aggregate Demand and Aggregate
Supply


Shows the amount of Real GDP that the
private, public and foreign sector collectively
desire to purchase at each possible price level
The relationship between the price level and
the level of Real GDP is inverse

See graph 
PL
Aggregate
Demand Curve
AD
GDPR

Real-Balances Effect



Interest-Rate Effect



When the price-level is high households and businesses
cannot afford to purchase as much output.
When the price-level is low households and businesses can
afford to purchase more output.
A higher price-level increases the interest rate which tends
to discourage investment
A lower price-level decreases the interest rate which tends
to encourage investment
Foreign Purchases Effect
A higher price-level increases the demand for relatively
cheaper imports
 A lower price-level increases the foreign demand for
relatively cheaper U.S. exports

There are two parts to a shift in AD:





A change in C, IG, G and/or XN
A multiplier effect that produces a greater change
than the original change in the 4 components
Increases in AD = AD 
Decreases in AD = AD 
Increase in Aggregate Demand
PL
AD
AD1
GDPR
Decrease in Aggregate Demand
PL
AD1
AD
GDPR
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Consumption (C)
Gross Private Investment (IG)
Government Spending (G)
Net Exports (XN) = Exports - Imports (X – M)

Household spending is affected by:

Consumer wealth
 More wealth = more spending (AD shifts )
 Less wealth = less spending (AD shifts )

Consumer expectations
 Positive expectations = more spending (AD shifts )
 Negative expectations = less spending (AD shifts )

Household indebtedness
 Less debt = more spending (AD shifts )
 More debt = less spending (AD shifts )

Taxes
 Less taxes = more spending (AD shifts )
 More taxes = less spending (AD shifts )

Investment Spending is sensitive to:

The Real Interest Rate
 Lower Real Interest Rate = More Investment (AD)
 Higher Real Interest Rate = Less Investment (AD)

Expected Returns
 Higher Expected Returns = More Investment (AD)
 Lower Expected Returns = Less Investment (AD)
 Expected Returns are influenced by
 Expectations of future profitability
 Technology
 Degree of Excess Capacity (Existing Stock of Capital)
 Business Taxes

Hyperlink to InvestmentDemand.pps
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More Government Spending (AD)
Less Government Spending (AD)

Net Exports are sensitive to:

Exchange Rates (International value of $)
 Strong $ = More Imports and Fewer Exports = (AD )
 Weak $ = Fewer Imports and More Exports = (AD )

Relative Income
 Strong Foreign Economies = More Exports = (AD )
 Weak Foreign Economies = Less Exports = (AD )

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AD reflects an inverse relationship between PL and
GDPR
Δ in PL creates real-balance, interest-rate, and foreign
purchase effects that explain AD’s downward slope
Δ in C, IG, G, and/or XN cause Δ in GDPR because
they Δ AD.
Increase in AD = AD 
Decrease in AD = AD 

The level of Real GDP (GDPR) that firms will
produce at each Price Level (PL)

Long-Run


Period of time where
input prices are
completely flexible and
adjust to changes in the
price-level
In the long-run, the level
of Real GDP supplied is
independent of the pricelevel

Short-Run


Period of time where
input prices are sticky
and do not adjust to
changes in the price-level
In the short-run, the level
of Real GDP supplied is
directly related to the
price level
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
The Long-Run Aggregate Supply or LRAS marks the
level of full employment in the economy (analogous
to PPC)
Because input prices are completely flexible in the
long-run, changes in price-level do not change firms’
real profits and therefore do not change firms’ level
of output. This means that the LRAS is vertical at the
economy’s level of full employment
PL
LRAS
Yf
GDPR

Because input prices are sticky in the short-run, the
SRAS is upward sloping.This reflects the fact that in
the short-run, increases in the price-level increase
firm’s profits and create incentives to increase
output. As the price-level falls, firm’s profits drop
and this creates an incentive to reduce output.
PL
SRAS
GDPR



An increase in SRAS is seen as a shift to the right.
SRAS 
A decrease in SRAS is seen as a shift to the left. SRAS

The key to understanding shifts in SRAS is per unit
cost of production
Per-unit production cost = total input cost/total output
PL
SRAS
GDPR
SRAS1
PL
SRAS1
SRAS
GDPR

Input Prices

Productivity

Legal-Institutional Environment

Domestic Resource Prices




Foreign Resource Prices
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


Strong $ = lower foreign resource prices
Weak $ = higher foreign resource prices
Market Power


Wages (75% of all business costs)
Cost of capital
Raw Materials (commodity prices)
Monopolies and cartels that control resources control the
price of those resources
Increases in Resource Prices = SRAS 
Decreases in Resource Prices = SRAS 



Productivity = total output/total inputs
More productivity = lower unit production cost =
SRAS 
Lower productivity = higher unit production cost =
SRAS 

Taxes and Subsidies



Taxes ($ to gov’t) on business increase per unit production
cost = SRAS 
Subsidies ($ from gov’t) to business reduce per unit
production cost = SRAS 
Government Regulation


Government regulation creates a cost of compliance = SRAS

Deregulation reduces compliance costs
= SRAS 

The equilibrium of AS & AD determines current
output (GDPR) and the price level (PL)
PL
LRAS
SRAS
P
AD
YF
GDPR

Full Employment equilibrium exists where AD
intersects SRAS & LRAS at the same point.
PL
LRAS
SRAS
P
AD
YF
GDPR

A recessionary gap exists when equilibrium occurs
below full employment output.
LRAS
PL
SRAS
P
AD
Y
YF
GDPR

An inflationary gap exists when equilibrium occurs
beyond full employment output.
PL
LRAS
SRAS
P
AD
YF Y
GDPR

Δ Consumption (C)



C↑ .: AD  .: GDPR↑ & PL↑ .: u%↓ & π%↑
C↓ .: AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓
Δ Gross Private Investment (IG)
IG↑ .: AD  .: GDPR↑ & PL↑ .: u%↓ & π%↑
 IG↓ .: AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓


Δ Government Spending (G)
G↑ .: AD  .: GDPR↑ & PL↑ .: u%↓ & π%↑
 G↓ .: AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓


Δ Net Exports (XN)


XN↑ .: AD  .: GDPR↑ & PL↑ .: u%↓ & π%↑
XN↓ .: AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓
LRAS
PL


P1
P
SRAS
AD1
AD

Y
YF
GDPR
C↑, IG↑, G↑ and/or XN↑ .: AD  .: GDPR↑ & PL↑ .: u%↓ & π%↑
LRAS
SRAS

P

PL
P1
AD

YF
Y
AD1
GDPR
C↓, IG↓, G↓ and/or XN↓ .: AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓

Δ Input Prices
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
Δ Productivity
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Input Prices↓ .: SRAS  .: GDPR↑ & PL↓ .: u%↓ & π%↓
Input Prices↑ .: SRAS  .: GDPR↓ & PL ↑ .: u%↑ & π%↑
Productivity↑ .: SRAS  .: GDPR↑ & PL↓ .: u%↓ & π%↓
Productivity↓ .: SRAS  .: GDPR↓ & PL ↑ .: u%↑ & π%↑
Δ Legal-Institutional Environment


Deregulation .: SRAS  .: GDPR↑ & PL↓ .: u%↓ & π%↓
Regulation .: SRAS  .: GDPR↓ & PL ↑ .: u%↑ & π%↑
SRAS
LRAS
PL
SRAS1


P
P1
AD

Y
YF
GDPR
Input Prices↓, Productivity↑, and/or Deregulation
.: SRAS  .: GDPR↑ & PL↓ .: u%↓ & π%↓
SRAS1
LRAS
PL
SRAS


P1
P

Y1 YF
AD
GDPR
Input Prices↑, Productivity↓, and/or Regulation
.: SRAS  .: GDPR↓ & PL↑ .: u%↑ & π%↑

ΔC, ΔIG, ΔG, and/or ΔXN = Δ AD



Δ Input Prices, Δ Productivity,
and/or Δ Regulation = Δ SRAS




AD  .: GDPR↑ & PL↑ .: u%↓ & π%↑
AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓
SRAS  .: GDPR↑ & PL↓ .: u%↓ & π%↓
SRAS  .: GDPR↓ & PL ↑ .: u%↑ & π%↑
The AS/AD Model is the most important graph in
AP Macroeconomics.
KNOW IT!!!