chapter 10 lecture presentation - dasha safonovadashasafonova.com/spring16/w10_as-ad_handout.pdf ·...

3/15/16

1

© 2016 Pearson Education

W10: AS-AD Model •  Short run vs. long run

•  Aggregate supply

•  Aggregate demand

•  Short run and long run macroeconomic equilibria

•  Business cycle in the AS-AD model

•  Inflation cycles

Reading: •  CH10 pg.242-254 •  CH12 pg.296, 301-09, until “The quantity theory of money”

HW: TBA


Short Run vs. Long Run

We distinguish two time frames associated with different states of the labor market:

§  Short-run – nominal wages do not change

§  Long-run – nominal wages change


The quantity of real GDP supplied is the total quantity that firms plan to produce during a given period

Short-run aggregate supply is the relationship between the quantity of real GDP supplied and the price level when the nominal wages, the prices of other resources, and potential GDP remain constant

Long-run aggregate supply is the relationship between the quantity of real GDP supplied and the price level when real GDP equals potential GDP

Aggregate Supply

3/15/16

2


Short Run and Long Run Aggregate Supply


Short Run and Long Run Aggregate Supply


Increase in Potential GDP

Potential GDP increases for three reasons:

§  An increase in the full-employment quantity of labor

§  An increase in the quantity of capital (physical or human)

§  An advance in technology

3/15/16

3


Increase in Potential GDP


Aggregate Demand

The quantity of real GDP demanded:

Y = C + I + G + X – M

Aggregate demand is the relationship between the quantity of real GDP demanded and the price level


Aggregate Demand Curve

3/15/16

4


Why Is AD Curve Downward Sloping?

A rise in the price level, all else held constant, decreases real wages

ê

People decrease spending

ê

The quantity of real GDP demanded decreases


Changes in Aggregate Demand

Aggregate demand curve shifts because of:

§  Expectations about future incomes and inflation

§  Fiscal policy and monetary policy

§  The world economy


Changes in Aggregate Demand

3/15/16

5


Short-Run Macroeconomic Equilibrium

Short-run macroeconomic equilibrium occurs when the quantity of real GDP demanded equals the quantity of real GDP supplied at the point of intersection of the AD curve and the SAS curve


Short-Run Macroeconomic Equilibrium


Long-run macroeconomic equilibrium occurs when real GDP equals potential GDP – when the economy is on its LAS curve

Long-run equilibrium occurs at the intersection of the AD and LAS curves

Long-Run Macroeconomic Equilibrium

3/15/16

6






What Is Business Cycle?

Peak

Trough

Contraction

Expa

nsio

n

Peak

Trough

Expa

nsio

n Contraction

3/15/16

7


US Business Cycle Expansions and Contractions

•  Contractions (recessions) start at the peak of a business cycle and end at the trough

•  Expansions start at the trough of a business cycle and end at the peak

•  Cycle: 1.  Trough from previous trough or 2.  Peak from previous peak

http://www.nber.org/cycles.html


Mainstream Business Cycle Theory

•  Potential GDP grows at a steady pace

•  Aggregate demand grows at a fluctuating rate

•  Real GDP fluctuates around potential GDP


Potential GDP increases to $16 trillion and the LAS curve shifts rightward.

The Business Cycle

3/15/16

8


The Business Cycle

During an expansion, aggregate demand increases and usually by more than potential GDP.

The AD curve shifts to AD1.


The Business Cycle

The SAS shifts to SAS1.


The Business Cycle

But if aggregate demand increases more slowly than potential GDP, the AD curve shifts to AD2.

3/15/16

9


The Business Cycle

But if aggregate demand increases more quickly than potential GDP, the AD curve shifts to AD3.


Inflation Cycles •  In the long run, inflation occurs if the quantity of money

grows faster than potential GDP

•  In the short run, many factors can start an inflation, and real GDP and the price level interact

•  To study these interactions, we distinguish between two sources of inflation:

§  Demand-pull inflation §  Cost-push inflation


Demand-Pull Inflation

An inflation that starts because aggregate demand increases

Examples:

•  a cut in the interest rate

•  an increase in the quantity of money

•  an increase in government expenditure

•  a tax cut

•  an increase in investment stimulated by an increase in expected future profits

3/15/16

10







3/15/16

11


Cost-Push Inflation

An inflation that starts with an increase in costs

Two main sources of increased costs: 1. An increase in the money wage rate 2. An increase in the money price of raw materials, such as oil


Cost-Push Inflation


•  The initial increase in costs creates a one-time rise in the price level, not inflation

•  To create inflation, aggregate demand must increase

•  That is, the Fed must increase the quantity of money persistently

Cost-Push Inflation

3/15/16

12


Cost-Push Inflation


Cost-Push Inflation

chapter 10 lecture presentation - dasha safonovadashasafonova.com/spring16/w10_as-ad_handout.pdf ·...

Documents