aggregate demand and supply rittenberg macroeconomics chapter 7 rittenberg macroeconomics chapter 7

Aggregate Demand and Supply

Rittenberg Macroeconomics

Chapter 7

Rittenberg Macroeconomics

Chapter 7

Why the Aggregate Demand Curve Slopes Downward (1)

• Aggregate demand (AD) is the economy-wide demand for goods and services.

• Like the market demand curve, the aggregate demand curve slopes downward, but for different reasons.

• The reasons for its downward slope are price-level effects:– Wealth Effect (Real Wealth/Real Balances) – Interest Rate Effect– International Trade Effect (Substitution)

2

1.1 The Slope of the Aggregate Demand Curve

• Aggregate demand is the relationship between the total quantity of goods and services demanded (from all the four sources of demand) and the price level, ceteris paribus.

• The aggregate demand curve is a graphical representation of aggregate demand.

• The wealth effect is the tendency for a change in the price level to affect real wealth and thus alter consumption.

1.1 The Slope of the Aggregate Demand Curve

• The interest rate effect is the tendency for a change in the price level to affect the interest rate and thus to affect the quantity of investment demanded.

• The international trade effect is the tendency for a change in the price level to affect net exports.

• The change in the aggregate quantity of goods and services demanded refers to a movement along an aggregate demand curve in response to a change in price level, ceteris paribus.

1.2 Changes in Aggregate Demand

• A Change in aggregate demand is a change in the aggregate quantity of goods and services demanded at every price level. This can be caused by changes in…

– Consumption,– Investment,– Government purchases,– Net exports.

• The exchange rate is the price of a currency in terms of another currency or currencies.


6

The Interest Rate Effect

7


8

The Aggregate Demand

Curve

Copyright © Houghton Mifflin Company. All rights reserved.

9

Note that changes in price level result in changes in the aggregate quantity demanded.

Factors that Affect AD

• Consumption– Income– Wealth– Expectations– Demographics– Taxes

• Investment– Interest Rates– Technology– Cost of Capital Goods– Capacity Utilization

10

AD = C + I + G + XN

Government purchases

Net Exports– Domestic & Foreign

Income– Domestic & Foreign Prices– Exchange Rates– Government Policy

Non-price Determinants: Changes in Aggregate Demand (1)


11

Nonprice Determinants: Changes in Aggregate Demand (2)


12

Non-price Determinants: Changes in Aggregate Demand (3)


13

Shifting the Aggregate

Demand Curve


14

The Multiplier

• The multiplier is the ratio of the change in the quantity of real GDP demanded at each price level to the initial change in one or more components of aggregate demand that produced it.

EQUATION 1.1Multiplier = Δ (real GDP demanded at each price level)

initial Δ (component of AD)

EQUATION 1.2 Δ (real GDP demanded at each price level) = Multiplier ×

initial Δ (component of AD)

The Multiplier

AD1AD2

Effect of initial increase in net exports without

multiplier effect

The Multiplier

AD1AD2

Effect of initial decrease in net exports without

multiplier effect

Effects of a Change in Aggregate Demand


18

Demand-pull inflation: rapid increases in AD outpace the growth of AS, causing price level increases (inflation).

© 2013, published by Flat World Knowledge

2. AGGREGATE DEMAND AND AGGREGATE SUPPLY: THE LONG RUN AND THE SHORT

RUN

Learning Objectives1. Distinguish between the short run and the long run, as these

terms are used in macroeconomics.2. Draw a hypothetical long-run aggregate supply curve and

explain what it shows about the natural levels of employment and output at various price levels, given changes in aggregate demand.

3. Draw a hypothetical short-run aggregate supply curve, explain why it slopes upward, and explain why it may shift; that is, distinguish between a change in the aggregate quantity of goods and services supplied and a change in short-run aggregate supply.

4. Discuss various explanations for wage and price stickiness.5. Explain and illustrate what is meant by equilibrium in the

short run and relate the equilibrium to potential output.

2. AGGREGATE DEMAND AND AGGREGATE SUPPLY: THE LONG RUN AND THE SHORT

RUN

• The short run in macroeconomic analysis, is a period in which wages and some other prices are sticky and do not respond to changes in economic conditions.

• A sticky price is a price that is slow to adjust to its equilibrium level, creating sustained periods of shortage or surplus.

• The long run in macroeconomic analysis, is a period in which wages and prices are flexible.

Short-run Aggregate Supply

• Aggregate Supply (AS) is the total of all the firm (market) supply curves.

• It shows the quantity of real GDP produced at different price levels.

• Like Supply at the microeconomic level, it is a positive, upward-sloping curve

21

Short-run Aggregate Supply

• Short-run AS slopes upward because an increase in the price level (while production costs (wages) and capital are held constant on the short-run), means higher profit margins—firms will want to produce more. – The reverse is true when price level falls….

• Sticky Prices: esp. Sticky Wages: Changes in Nominal Wages tend to lag behind changes in price level. This leads to a short term effective change in REAL WAGE.

22

Aggregate Supply


23

Shape of Short-run AS (SRAS)• In the short-run, the capital stock (the number of

factories and machines, etc.) are held constant.• Increasing the number of workers increases output,

but at a diminishing rate. • Diminishing returns manifest as an ever-steeper SRAS

curve.• In the short-run, some prices do not adjust quickly;

they are “sticky”:– Labor Costs (wages)– Contracted supplies– “Sticky” prices effect the short-run equillibrium

24

The Shape of the Short-Run

Aggregate Supply Curve


25

The Shape of Long-run AS (LRAS)• Resource costs are NOT fixed.

– As prices rise, workers will want higher wages and will eventually get them.

• The amount of capital is not fixed—firms can build new plants and buy new equipment over the long-run.

• In the long-run, AS is set by the production possibilities curve—the capacity of the economy, and is not affected by prices, hence is vertical.

26

2.1 The Long Run

• The long run aggregate supply (LRAS) curve is a graphical representation that relates the level of output produced by firms to the price level in the long run.

The Shape of the Long-Run Aggregate Supply Curve


28

Long-Run Equilibrium

Determinants of Aggregate Supply (1)


30



31



32

2.2 The Short Run

• The short run aggregate supply (SRAS) curve is a graphical representation of the relationship between production and the price level in the short run.

• A change in the aggregate quantity of goods and services supplied is characterized by movement along the short-run aggregate supply curve.

• A change in short-run aggregate supply is characterized by a change in the aggregate quantity of goods and services supplied at every price level in the short-run.

Shifting the Long-Run Aggregate Supply Curve


34

Growth occurs as the labor force and the capital stock grow, as technological innovation improves production efficiency.

Changes in Short-Run Aggregate

Supply


35


Changes in Short-Run Aggregate Supply

SRAS1 SRAS2SRAS3

Shift caused by decrease in

price of natural resources.

Shift caused by increase in

price of natural resources.


Short-Run Equilibrium

SRAS1SRAS2

Shift caused by increase in health insurance premium

paid by firms

AD1

Y2 Y1

P1

P2


Short-Run Equilibrium

SRAS1

AD2

Shift caused by increase in government purchases.

AD1

Y2Y1

P1

P2

Effects of a Change in

Aggregate Supply


39

Cost-push inflation: cost increases push AS to the left (relative to AD), causing price level increases (inflation).

Aggregate Demand and

Aggregate Supply

Equilibrium

40

Aggregate Demand and

Supply Equilibrium

41


42


43


44


45


46


47

Economic Insight: OPEC and Aggregate Supply

48

aggregate demand and supply rittenberg macroeconomics chapter 7 rittenberg macroeconomics chapter 7

Documents

aggregate demand ad

components of aggregate

aggregate demand curve

sources of demand

market demand curve

aggregate quantity of

economywide demand

pricelevel effects