Transcript Chapter 21
Chapter 10
Aggregate
Demand and
Aggregate Supply:
The Basic Model
The Basics of Aggregate Demand
• Aggregate demand refers the real value
of all new, final, domestically produced
goods and services that households,
firms, governments, and the foreign
sector are willing and able to purchase at
a given set of price levels, ceteris paribus.
The Basics of Aggregate Demand (cont’d)
• AD equals:
Consumption Spending by Households, plus
Investment Expenditures by Firms, plus
Government Expenditures, plus
Net Exports
• AD C I G (X M )
The Price Level and Aggregate Demand
• The overall price level is the major determinant
of total spending in the economy.
• Aggregate demand curve shows relationship
between the price level and total spending
What is the relationship??
Figure 10.1
The Aggregate Demand Curve
Why the Aggregate Demand Curve
Slopes Downward
• There are three basic reasons:
The Wealth Effect
• As prices decrease you feel wealthier because you can buy
more
The Interest Rate Effect
• As prices fall don’t have to spend as much save more
interest rates fall encourage borrowing changes AD
The International Trade Effect
• As prices fall buy more US good imports fall other
countries see that our goods are cheaper exports
increase
Basic Movements in Aggregate Demand
• Change in aggregate quantity demanded
Caused by a change in the overall price level.
Shown by a movement along the aggregate demand
curve
Basic Movements in
Aggregate Demand (cont’d)
• A change in aggregate demand is caused by
changes in forces other than the price level:
Macroeconomic policy influences
• Changing interest rates, changing taxes, changes in
government spending
Expectations
• Consumer confidence
Global influences
• Purchasing power of the dollar
• Represented by a shift of the aggregate
demand curve
Table 10.1 Key Influences on Changes in
Aggregate Demand
Figure 10.2
Change in Aggregate Demand
Can we do it??
• Let’s try number 2…
• How will the following actions of
macroeconomic policy affect the US aggregate
demand curve?
Social Security taxes are increased to extend the life
of the Social Security system
• AD shift to the left
The federal government expends its spending on
prescription drug benefits under Medicare
• AD shift to the right
Consumers expect more disposal income in the
future as temporary tax cuts are made permanent
• AD shift to the right
The Basics of Aggregate Supply
• Aggregate supply is the real value of all final,
domestically produced goods and services that
firms are willing to offer for sale at various price
levels, ceteris paribus.
• There are two different aggregate
supply curves:
The Short-Run AS Curve
The Long-Run AS Curve
Aggregate Supply in the Short Run
• The short run is a period of time that is too
short for firms to adjust fully to changes in the
price level.
Workers face sticky wages.
• Can’t change nominal wages easily when prices change
Firms face sticky prices.
• Can’t always increase the price of your product
Firms and workers may have mistaken estimates of
nominal prices.
• May not have all the information right OOPS
The Price Level and
Short-Run Aggregate Supply
• In the short run, a higher price level will cause
firms to produce more goods and services.
The short-run aggregate supply curve is
upward-sloping.
Why the Short-Run Aggregate Supply
Curve Slopes Upward
• A higher price level provides an incentive for
firms to increase output.
Based on the process of profit maximization
Profit per Unit Product
Production Cost
of Output
Price
per Unit of Output
Note: If price rises faster than costs,
profitability increases.
Why the Short-Run Aggregate Supply
Curve Slopes Upward (cont’d)
• Resource prices (such as nominal wages)
are sticky.
They change more slowly than output prices.
• As price levels rise faster than production
costs, profit per unit increases, and firms
have an incentive to increase output.
Basic Movements in Short-Run
Aggregate Supply (cont’d)
• A change in the price level is represented by a
movement along a short-run aggregate supply
curve.
This is called a change in aggregate quantity
supplied.
Figure 10.3
The Short-Run Aggregate Supply Curve
Changes in Short-Run Aggregate Supply
• Changes in other factors other than price can
affect profitability at a given price level:
Nominal resource prices, especially nominal wages
• Wages account for 2/3 of total production costs
Productivity
• Workers become more efficient and produce more
Producers’ expectations
• What do firms think will happen in the future?
These changes will shift the entire aggregate supply
curve.
Figure 10.4
Change in Short-Run Aggregate Supply
Can we do it??
• Let’s try number 6…
• For a given industry, let the product price per unit = $5 and the
production cost per unit = $3
Based on this information, what is the profit per unit for this producer?
• $2 * number of units sold
Now let the product price increase to $6 per unit, and the production
cost per unit increase to $3.50 per unit. What is the profit per unit now
for this producer?
• $2.50 * number of units sold
How should this producer change his production plans in the face of
the changing profit per unit?
• Should increase production
If many producers faced the same situation, how would this affect the
AS curve?
• Because it is a PRICE change AS will not shift change in Aggregate
Quantity Supplied