Transcript Economics R. Glenn Hubbard, Anthony Patrick O’Brien, 3e.

Chapter 12: Aggregate Demand and Aggregate Supply Analysis
CHAPTER
12
Aggregate Demand
and Aggregate
Supply Analysis
Prepared by:
Fernando Quijano
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12.1 LEARNING OBJECTIVE
Aggregate Demand
Identify the determinants of aggregate
demand and distinguish between a
movement along the aggregate
demand curve and a shift of the curve.
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Aggregate demand and aggregate supply model
A model that explains short-run fluctuations in real
GDP and the price level.
FIGURE 12-1
Aggregate Demand and
Aggregate Supply
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12.1 LEARNING OBJECTIVE
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Aggregate Demand
Identify the determinants of aggregate
demand and distinguish between a
movement along the aggregate
demand curve and a shift of the curve.
Aggregate demand (AD) curve A curve that
shows the relationship between the price level
(P) and the quantity of real GDP (Y) demanded
by households, firms, and the government.
Short-run aggregate supply (SRAS) curve A
curve that shows the relationship in the short-run
between the price level (P) and the quantity of
real GDP (Y) supplied by firms.
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12.1 LEARNING OBJECTIVE
Aggregate Demand
Identify the determinants of aggregate
demand and distinguish between a
movement along the aggregate
demand curve and a shift of the curve.
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Why does the AD curve slope downward?
GDP has four components: consumption (C),
investment (I), government purchases (G), and net
exports (NX). If we let Y stand for GDP, we can write
the following:
Y = C + I + G + NX
Reason # 1: The Wealth Effect
How a Change in the Price Level Affects Consumption
The impact of the price level on consumption is called
the wealth effect.
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12.1 LEARNING OBJECTIVE
Aggregate Demand
Identify the determinants of aggregate
demand and distinguish between a
movement along the aggregate
demand curve and a shift of the curve.
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Reason # 2: The Interest-Rate Effect
How a Change in the Price Level Affects Investment
The impact of the price level on investment is
known as the interest-rate effect.
Reason # 3: The International-Trade Effect
How a Change in the Price Level Affects Net Exports
The impact of the price level on net exports is
known as the international-trade effect.
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12.1 LEARNING OBJECTIVE
Aggregate Demand
Identify the determinants of aggregate
demand and distinguish between a
movement along the aggregate
demand curve and a shift of the curve.
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
A “shift” of the aggregate demand curve vs a “movement along”
An important point to remember is that the aggregate
demand curve tells us the relationship between the
price level and the quantity of real GDP demanded,
holding everything else constant.
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12.1 LEARNING OBJECTIVE
Aggregate Demand
Identify the determinants of aggregate
demand and distinguish between a
movement along the aggregate
demand curve and a shift of the curve.
Variables That Shift the AD Curve
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
The variables that cause the aggregate demand curve
to shift fall into three categories:
1. changes in government policies
2. changes in the expectations of
households and firms
3. changes in foreign variables
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12.1 LEARNING OBJECTIVE
Aggregate Demand
Identify the determinants of aggregate
demand and distinguish between a
movement along the aggregate
demand curve and a shift of the curve.
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Changes in Government Policies
Monetary policy The actions the Federal
Reserve takes to manipulate the money
supply or the interest rate to pursue
macroeconomic policy objectives.
Fiscal policy Changes in federal taxes or
purchases that are intended to achieve
macroeconomic policy objectives.
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12.1 LEARNING OBJECTIVE
Aggregate Demand
Identify the determinants of aggregate
demand and distinguish between a
movement along the aggregate
demand curve and a shift of the curve.
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Changes in the Expectations of Households and Firms
If households become more optimistic about their
future incomes, they are likely to increase their
current consumption.
Changes in Foreign Variables
If firms and households in other countries buy
fewer U.S. goods or if firms and households in the
United States buy more foreign goods, net exports
will fall, and the aggregate demand curve will shift
to the left.
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12.1 LEARNING OBJECTIVE
Solved Problem
12-1
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Movements along the Aggregate Demand Curve
versus Shifts of the Aggregate Demand Curve
Identify the determinants of aggregate
demand and distinguish between a
movement along the aggregate
demand curve and a shift of the curve.
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12.2 LEARNING OBJECTIVE
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Aggregate Supply
Identify the determinants of
aggregate supply and distinguish
between a movement along the
short-run aggregate supply curve
and a shift of the curve.
Long-run aggregate supply
(LRAS) curve A curve that shows
the relationship in the long-run
between the price level (P) and the
quantity of real GDP supplied (Y).
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12.2 LEARNING OBJECTIVE
Aggregate Supply
The Long-Run Aggregate Supply Curve
Identify the determinants of
aggregate supply and distinguish
between a movement along the
short-run aggregate supply curve
and a shift of the curve.
FIGURE 12-2
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
The LRAS Curve
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12.2 LEARNING OBJECTIVE
Aggregate Supply
The Short-Run Aggregate Supply Curve
Identify the determinants of
aggregate supply and distinguish
between a movement along the
short-run aggregate supply curve
and a shift of the curve.
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
The three most common explanations as to why the
Keynesian short-run aggregate supply curve slopes
upward include:
1. Contracts make some wages and prices “sticky.”
2. Firms are often slow to adjust wages.
3. Menu costs make some prices sticky.
Menu costs The costs to
firms of changing prices.
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12.2 LEARNING OBJECTIVE
Aggregate Supply
Variables That Shift the SRAS Curve
Identify the determinants of
aggregate supply and distinguish
between a movement along the
short-run aggregate supply curve
and a shift of the curve.
1. increases in the labor force and in the capital stock (K)
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
2. positive or negative technological change
3. expected changes in the future price level
4. unexpected changes in the price of a natural resource
Supply shock An unexpected event
that causes the short-run aggregate
supply curve to shift.
5. workers and firms adjusting to errors in their past expectations
about the price level
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12.2 LEARNING OBJECTIVE
Aggregate Supply
Identify the determinants of
aggregate supply and distinguish
between a movement along the
short-run aggregate supply curve
and a shift of the curve.
Most important: Expected changes in the future price level!
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
FIGURE 12-3
How Expectations of the
Future Price Level Affect
the SRAS curve
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12.3 LEARNING OBJECTIVE
Macroeconomic Equilibrium
in the Long-Run and the Short-Run
Use the aggregate demand and
aggregate supply model to illustrate
the difference between short-run and
long-run macroeconomic equilibrium.
FIGURE 12-4
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Long-Run Macroeconomic
Equilibrium
A “long-run equilibrium” is
also called a “general”
equilibrium because all
markets are simultaneously
in equilibrium.
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Macroeconomic Equilibrium
in the Long-Run and the Short-Run
12.3 LEARNING OBJECTIVE
Use the aggregate demand and
aggregate supply model to illustrate
the difference between short-run and
long-run macroeconomic equilibrium.
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
The simple (static) AD-LRAS-SRAS model
Because the full analysis of the aggregate demand and
aggregate supply model can be complicated, we begin
with a simplified case, using two assumptions:
1. The economy has not been experiencing
any inflation. The price level is currently
100, and workers and firms expect it to
remain at 100 in the future.
2. The economy is not experiencing any longrun growth. Potential real GDP is $14.0
trillion and will remain at that level in the
future.
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Macroeconomic Equilibrium
in the Long-Run and the Short-Run
12.3 LEARNING OBJECTIVE
Use the aggregate demand and
aggregate supply model to illustrate
the difference between short-run and
long-run macroeconomic equilibrium.
The simple (static) AD-LRAS-SRAS model
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
FIGURE 12-5
The SR and LR equilibria
from a decrease in
aggregate demand
Example: A negative AD shock
in the simple (static) model
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Macroeconomic Equilibrium
in the Long-Run and the Short-Run
12.3 LEARNING OBJECTIVE
Use the aggregate demand and
aggregate supply model to illustrate
the difference between short-run and
long-run macroeconomic equilibrium.
The simple (static) AD-LRAS-SRAS model
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
FIGURE 12-6
The SR and LR equilibria
from an increase in
aggregate demand
Example: A positive AD shock in
the simple (static) model
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Macroeconomic Equilibrium
in the Long-Run and the Short-Run
The simple (static) AD-LRAS-SRAS model
12.3 LEARNING OBJECTIVE
Use the aggregate demand and
aggregate supply model to illustrate
the difference between short-run and
long-run macroeconomic equilibrium.
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
FIGURE 12-7
The SR and LR
equilibria from a
decrease in
aggregate supply
Example:
A negative
supply shock
in the simple
(static) model
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Macroeconomic Equilibrium
in the Long-Run and the Short-Run
12.3 LEARNING OBJECTIVE
Use the aggregate demand and
aggregate supply model to illustrate
the difference between short-run and
long-run macroeconomic equilibrium.
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Why are negative supply shocks so dangerous to an economy?
Stagflation A combination
of inflation and recession,
usually resulting from a
supply shock.
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Making
12.3 LEARNING OBJECTIVE
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
How Long Does It Take to Return
the to Potential GDP? A View from
Connection the Obama Administration
Use the aggregate demand and
aggregate supply model to illustrate
the difference between short-run and
long-run macroeconomic equilibrium.
The difficulty in predicting how much
aggregate demand and aggregate supply
will shift means that economists often have
difficulty correctly predicting the beginning
and end of recessions.
Christina Romer, the chair of the
Council of Economic Advisers in
the Obama Administration,
provided an estimate of how long
the economy would take to return
to potential GDP.
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A Dynamic Aggregate Demand
and Aggregate Supply Model
12.4 LEARNING OBJECTIVE
Use the dynamic aggregate demand
and aggregate supply model to
analyze macroeconomic conditions.
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
The complete (dynamic) AD-LRAS-SRAS model
We can create a dynamic aggregate demand and
aggregate supply model by making three changes to
our simple (static) model.
1. Potential real GDP increases continually, shifting
the LRAS curve to the right.
2. During most years, the AD curve shifts to the right.
3. Except during periods when workers and firms
expect high rates of inflation, the SRAS curve shifts
to the right.
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A Dynamic Aggregate Demand
and Aggregate Supply Model
12.4 LEARNING OBJECTIVE
Use the dynamic aggregate demand
and aggregate supply model to
analyze macroeconomic conditions.
The complete (dynamic) AD-LRAS-SRAS model
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
FIGURE 12-8
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A Dynamic Aggregate Demand
and Aggregate Supply Model
12.4 LEARNING OBJECTIVE
Use the dynamic aggregate demand
and aggregate supply model to
analyze macroeconomic conditions.
The complete (dynamic) AD-LRAS-SRAS model
FIGURE 12-9
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Using dynamic AD-LRASSRAS to understand
inflation
Example: An overheating
economy where AD grows faster
than LRAS
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A Dynamic Aggregate Demand
and Aggregate Supply Model
12.4 LEARNING OBJECTIVE
Use the dynamic aggregate demand
and aggregate supply model to
analyze macroeconomic conditions.
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
The Great Recession of 2007-2009
The Great Recession began in December 2007,with
the end of the economic expansion that had begun in
November 2001. Several factors contributed to bring
on the recession:
the bursting of the housing bubble
the Financial Crisis of 2008
the rapid increase in oil prices during 2008
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A Dynamic Aggregate Demand
and Aggregate Supply Model
12.4 LEARNING OBJECTIVE
Use the dynamic aggregate demand
and aggregate supply model to
analyze macroeconomic conditions.
The Great Recession in the dynamic AD-LRAS-SRAS model
FIGURE 12-10
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
The Beginning of the Great
Recession of 2007–2009
Example: The economy grows
too slowly because LRAS grew
faster than AD (plus there is a
negative shock to SRAS)
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KEY TERMS
Aggregate demand and aggregate supply model
Chapter 12: Aggregate Demand and Aggregate Supply Analysis
Aggregate demand (AD) curve
Fiscal policy
Long-run aggregate supply (LRAS) curve
Menu costs
Monetary policy
Short-run aggregate supply (SRAS) curve
Stagflation
Supply shock
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