Aggregate Demand/Aggregate Supply The Alpha and Omega of Macroeconomics Graphs

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<ul><li>Slide 1</li></ul><p> Slide 2 Aggregate Demand/Aggregate Supply The Alpha and Omega of Macroeconomics Graphs Slide 3 Consumption Capital Production Possibilities Curve/Gross Domestic Product Connection.A.A 10 5 Assume this economy is fully employing all of its resources in the least costly way (Productive Efficiency) and chooses to produce at point A (Allocative Efficiency) Assume this economy can produce 5 Capital goods and services And 10 consumption goods and services Assume one capital G/S costs $5.00 and 1 consumption G/S costs $1.00 What is this economys GDP? 5 Capital G/S X $5.00 = $25.00 10 Consumption G/S x $1.00 = $10.00 GDP - $35.00 This GDP represents Full-Employment or Potential GDP. Real GDP Price Level LRAS $35 FE ***Point A on the PPC is the same thing as Full Employment Real GDP Represented by LRAS only expressed In $$$$$$*** Aggregate Demand/Aggregate Supply Slide 4 Price Level Real GDP FE RGDP LRAS 0 Between 0 and FE RGDP is a large range of Dollar value of GDP. EVERYONE of these Points to the LEFT of FE RGDP will represent RGDP values that are LESS than our Full-Employment POTENTIAL RGDP. Slide 5 Price Level Real GDP FE RGDP LRAS 0 REMEMBER: To Calculate RGDP we take Nominal GDP (Price x Quantity) and factor out changes in Price relative to a base year. Slide 6 Price Level Real GDP FE RGDP LRAS PL 1 RGDP 1 This is ACTUAL RGDPThis is POTENTIAL RGDP Slide 7 Price Level Real GDP FE RGDP LRAS PL 1 RGDP 1 If the economy was producing this amount of RGDP relative to the FE RGDP it is in serious trouble. It is way inside its productive capacity. Resource prices (Input prices) and wage rates are going to be low because there is VERY high Unemployment and a high supply of unused resources (Inputs) Slide 8 Price Level Real GDP FE RGDP LRAS RGDP 1 PL 1 RGDP2 If we move to the production of RGDP2 we can see the economy is using MORE of its slack resources to produce RGDP (Inputs AND people) BUT the Price Level is steadyThis is because we STILL have relatively HIGH Unemployment and there is still enough slack resources to keep their prices Low. Slide 9 Price Level Real GDP FE RGDP LRAS PL 1 RGDP 1 RGDP2RGDP3 This will continue over a range of RGDP production Slide 10 Price Level Real GDP FE RGDP LRAS PL 1 RGDP 1 RGDP2RGDP3RGDP4 This will continue over a range of RGDP production until we come to this next important point Slide 11 Price Level Real GDP FE RGDP LRAS PL 1 RGDP 1 RGDP2RGDP3RGDP4RGDP5 What we have constructed so far is a range of production of RGDP that the economy CAN produce, but is not desirableIn the LONG RUN we hope to be at FE RGDP, but because of the current conditions the economy, in the SHORT RUN, can produce any one of these RGDP levels Slide 12 Price Level Real GDP FE RGDP LRAS PL 1 RGDP 1 RGDP2RGDP3RGDP4RGDP5 Hence, we have ONE part of our SHORT RUN AGGREGATE SUPPLY CURVE---The Horizontal, or Keynesian, Range. Slide 13 Price Level Real GDP FE RGDP LRAS PL 1 RGDP 1 RGDP2RGDP3RGDP4RGDP5 This will continue over a range of RGDP production UNTIL . Slide 14 Price Level Real GDP FE RGDP LRAS PL 1 RGDP 1 RGDP2RGDP3RGDP4RGDP5RGDP6 We reach RGDP6Notice that NOW the Price Level INCREASES to PL2As we move closer to FE RGDP we are getting to LOWER levels of Unemployment and are using more input resources so now these limited resources are beginning to become MORE scarce. When inputs and wages start to rise, what happens to the Cost of Production?? INCREASES PL 2 Slide 15 Price Level Real GDP FE RGDP LRAS PL 1 RGDP 1 RGDP2RGDP3RGDP4RGDP5RGDP6RGDP7 Producers need to get a higher price to reflect the increasing input costs. The Producers will INCREASE the Quantity Supplied of RGDP when the Price Level INCREASES PL 2 PL3 Slide 16 Price Level Real GDP FE RGDP LRAS PL 1 RGDP 1 RGDP2RGDP3RGDP4RGDP5RGDP6RGDP7 RGDP8 PL 2 PL3 PL4 THIS POINT IS VERY IMPORTANT!!!! Slide 17 Price Level Real GDP FE RGDP LRAS PL 1 RGDP 1 RGDP2RGDP3RGDP4RGDP5RGDP6RGDP7 RGDP8 PL 2 PL3 PL4 At this point, ACTUAL RGDP is EQUAL to POTENTIAL RGDPThis economys ability to Produce RGDP in the SHORT RUN is now EQUAL to the Economys ability to Product RGDP in the LONG-RUN Slide 18 Price Level Real GDP FE RGDP LRAS PL 1 RGDP 1 RGDP2RGDP3RGDP4RGDP5RGDP6RGDP7 RGDP8 RGDP9 PL 2 PL3 PL4 PL5 What about this NEXT point? Can our economy produce at this point? Slide 19 Price Level Real GDP FE RGDP LRAS PL 1 RGDP 1 RGDP2RGDP3RGDP4RGDP5RGDP6RGDP7 RGDP8 RGDP9 PL 2 PL3 PL4 PL5 IN THE SHORT RUN it can, but it will NOT be sustainableNow Unemployment is BELOW the Natural Rate of Unemployment and Inputs are very scarce. The pressure on wages will INCREASE. The economy is up against a wall. There will not be any increase in Quantity Supplied at this point. Slide 20 Price Level Real GDP FE RGDP LRAS PL 1 RGDP 1 RGDP2RGDP3RGDP4RGDP5RGDP6RGDP7 RGDP8 RGDP9 PL 2 PL3 PL4 PL5 This Range of the SHORT RUN AGGREGATE SUPPLY CURVE is called the INTERMEDIATE RANGE Slide 21 Price Level Real GDP FE RGDP LRAS PL 1 RGDP 1 RGDP2RGDP3RGDP4RGDP5RGDP6RGDP7 RGDP8 RGDP9 PL 2 PL3 PL4 PL5 PL6 We have reach the END of this economys ability to Produce RGDP.The SHORT RUN AGGREGATE SUPPLY CURVE Becomes VERTICAL and Parallels the LRAS CURVE Slide 22 Price Level Real GDP FE RGDP LRAS PL 1 RGDP 1 RGDP2RGDP3RGDP4RGDP5RGDP6RGDP7 RGDP8 RGDP9 PL 2 PL3 PL4 PL5 PL6 PL7SRAS The VERTICAL RANGE of the SRAS Curve is called the Classical RangeMore on what the Classical and Keynesian Range mean later. Classical Range Slide 23 Price Level Real GDP FE RGDP LRAS PL 1 RGDP 1 RGDP2RGDP3RGDP4RGDP5RGDP6RGDP7 RGDP8 RGDP9 PL 2 PL3 PL4 PL5 PL6 PL7SRAS Lets take away all the stuff and see what we are left with. Classical Range Slide 24 Price Level Real GDP FE RGDP LRAS SRAS This is how I like to represent the SUPPLY-SIDE of the Economy. There are 3 distinct sections to the SRAS curve and it extends beyond the LRAS curve and then becomes vertical again.This just shows that an economy CAN produce beyond it productive capacity, but does so at its perilNow we will insert an Aggregate Demand Curve and start with serious analysis on the economy. Slide 25 Aggregate Supply (AS) Shifters Changes in spending not caused by Price Level Changes in INPUT prices for land, labor, capital, and entrepreneurship THE FACTORS OF PRODUCTION 1. Before the Change 2. The change 3. After the change Change in Market Power (unions, presence of monopolies) 1. Before the Change 2. The change 3. After the change Change in Productivity 1. Before the Change 2. The change 3. After the change Change in Government policies business taxes, subsudies, regulations Change in value of currency 1. Before the Change 2. The change 3. After the change Price Level GDP (AS) Slide 26 Price Level Real GDP SRAS Aggregate Demand /Aggregate Supply SRAS 1 Unions grow more aggressive; wage rate increases. Slide 27 Price Level Real GDP SRAS Aggregate Demand /Aggregate Supply SRAS 1 OPEC successfully increases oil price Slide 28 Price Level Real GDP SRAS Aggregate Demand /Aggregate Supply SRAS 1 Labor productivity increases dramatically Slide 29 Price Level Real GDP SRAS Aggregate Demand /Aggregate Supply SRAS 1 Giant natural gas discovery decreases energy prices. Slide 30 Price Level Real GDP SRAS Aggregate Demand /Aggregate Supply SRAS 1 Computer technology brings new levels of efficiency to industry. Slide 31 Price Level Real GDP SRAS Aggregate Demand /Aggregate Supply SRAS 1 Research shows that improved schools have increased the skills of American workers and managers. Slide 32 Price Level Real GDP SRAS Aggregate Demand /Aggregate Supply SRAS 1 Government increases regulation of industry to address pollution problem Slide 33 Price Level Real GDP SRAS Aggregate Demand /Aggregate Supply SRAS 1 The dollar depreciates in foreign exchange markets Slide 34 Price Level Real GDP SRAS Aggregate Demand /Aggregate Supply SRAS 1 President announces cuts in farm and business subsidies. Slide 35 Price Level Real GDP SRAS Aggregate Demand /Aggregate Supply SRAS 1 Business taxes fall. Slide 36 Price Level Real GDP SRAS Aggregate Demand /Aggregate Supply SRAS 1 New low-cost means of extracting oil from shale is discovered Slide 37 Introduction to Aggregate Demand AD GDP Price Level Slide 38 AD GDP Price Level Why is Aggregate Demand Curve Downward Sloping 1.According to the AD curve, what is the relationship between Price Level and Real GDP? There is an inverse relationship; the lower the price level, the higher the Real GDP or real output. Slide 39 AD GDP Price Level Why is Aggregate Demand Curve Downward Sloping Explain how each of the following effects helps explain why the AD curve is downward sloping? Interest Rate Effect A lower price level decreases the demand for money, which decreases the interest rate and increases investment and interest sensitive components of consumption and, therefore, Real GDP or real output. Slide 40 AD GDP Price Level Why is Aggregate Demand Curve Downward Sloping Wealth Effect or Real Balance Effect As the price level falls, cash balances will buy more so people will spend more, thus increasing Real GDP or Real Output. Slide 41 AD GDP Price Level Why is Aggregate Demand Curve Downward Sloping Net Export or International Trade Effect A lower U.S. price level means prices for goods produced in the U.S. are lower relative to the prices in foreign countries. Thus people will buy more U.S. produced goods and fewer foreign produced goods. This increases net exports, a component of GDP Slide 42 Aggregate Demand (AD) Shifters Changes in spending not caused by Price Level 1. Before the Change 2. The change 3. After the change Change in Net Exports (Nx) caused by a change in national income abroad, or exchange rate of money 1. Before the Change 2. The change 3. After the change Change in Government (G) spending 1. Before the Change 2. The change 3. After the change Change in Investment (I) caused by a change in interest rates, profit expectations, business taxes, technology, or excess capacity 1. Before the Change 2. The change 3. After the change Change in consumer spending (C) caused by a change in wealth, expectations, indebtedness, personal taxes PlPl Price Level GDP (AD) PlPl Price Level GDP (AD) GDP (AD) Price Level GDP (AD) Price Level GDP (AD) Slide 43 Bottom Line of Aggregate Demand (AD) Aggregate Demand is driven by the Components of GDP AD = C + I + G + N(x) When one of these variables change, either positively or negatively (increase or decrease), AD curve will move right or left Slide 44 In the slides that follow, read the situation and determine if it causes an increase, decrease or no change in AD. DO NOT CLICK ON THE YELLOW BARS. They are hot linked and will take you to a different part of the PPT. Just choose in your mind the direction you think AD will shift Slide 45 Increase AD Decrease AD No Change in AD Situation: Congress cuts taxes. Price Level Real GDP AD A B C Always start at curve B. Click the correct curve to go to the next slide. Slide 46 Increase AD Decrease AD No Change in AD Situation: Investment spending decreases. Price Level Real GDP AD A B C Always start at curve B. Click the correct curve to go to the next slide. Slide 47 Increase AD Decrease AD No Change in AD Situation: Government spending increases; President promises no tax increases. Price Level Real GDP AD A B C Always start at curve B. Click the correct curve to go to the next slide. Slide 48 Increase AD Decrease AD No Change in AD Situation: Survey shows consumer confidence jumps. Price Level Real GDP AD A B C Always start at curve B. Click the correct curve to go to the next slide. Slide 49 Increase AD Decrease AD No Change in AD Situation: Stock market collapses; investors lose billions. Price Level Real GDP AD A B C Always start at curve B. Click the correct curve to go to the next slide. Slide 50 Increase AD Decrease AD No Change in AD Situation: Productivity rises for the fourth straight year. Price Level Real GDP AD A B C Always start at curve B. Click the correct curve to go to the next slide. Slide 51 Increase AD Decrease AD No Change in AD Situation: President/Congress cut defense spending by 20 percent; no increase in domestic spending. Price Level Real GDP AD A B C Always start at curve B. Click the correct curve to go to the next slide. Slide 52 Increase AD Decrease AD No Change in AD Situation: Consumer indebtedness rises. Price Level Real GDP AD A B C Always start at curve B. Click the correct curve to go to the next slide. Slide 53 Increase AD Decrease AD No Change in AD Situation: Dollar appreciates in foreign exchange markets. Price Level Real GDP AD A B C Always start at curve B. Click the correct curve to go to the next slide. Slide 54 Increase AD Decrease AD No Change in AD Situation: Business profit expectations fall. Price Level Real GDP AD A B C Always start at curve B. Click the correct curve to go to the next slide. Slide 55 Increase AD Decrease AD No Change in AD Situation: The price of imported resources skyrockets. Price Level Real GDP AD A B C Always start at curve B. Click the correct curve to go to the next slide. Slide 56 Increase AD Decrease AD No Change in AD Situation: Consumers expect the price level to rise. Price Level Real GDP AD A B C Always start at curve B. Click the correct curve to go to the next slide. Slide 57 Increase AD Decrease AD No Change in AD Situation: Consumer wealth plummets as stock prices fall. Price Level Real GDP AD A B C Always start at curve B. Click the correct curve to go to the next slide. Slide 58 Increase AD Decrease AD No Change in AD Situation: Excess plant capacity decreases significantly. Price Level Real GDP AD A B C Always start at curve B. Click the correct curve to go to the next slide. Slide 59 Increase AD Decrease AD No Change in AD Situation: Interest rates rise. Price Level Real GDP AD A B C Always start at curve B. Click the correct curve to go to the next slide. Slide 60 Increase AD Decrease AD No Change in AD Situation: Foreign incomes fall. Price Level Real GDP AD A B C Always start at curve B. Click the correct curve to go to the next slide. Slide 61 Increase AD Decrease AD No Change in AD Situation: Dollar value depreciates in foreign exchange markets. Price Level Real GDP AD A B C Always start at curve B. Click the correct curve to go to the next slide. Slide 62 Price Level Real GDP SRAS LRAS FE RGDP AD1 PL 1 RGDP1 This AD/AS Model of the Economy shows an economy in TROUBLEAggregate Demand is intersecting Aggregate Supply on the HORIZONTAL section of SRAS...This economy is in a SEVERE RECESSON boardering on a DEPRESSION. Unemployment Rate 15%(?) Slide 63 Price Level Real GDP SRAS LRAS FE RGDP AD1 PL 1 RGDP1 A VERY large Recessionary Gap This means it is currently producing a RGDP that is WAY inside its ability to produce RGDP. Unemployment Rate 15%(?) Slide 64 Price Level Real GDP SRAS LRAS FE RGDP AD1 PL 1 RGDP1 AD2 RGDP2 Aggregate Demand INCREASES from AD1 to AD2 Still a LARGE Recessionary Gap But not a large as before Sti...</p>

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