national income and price determination. shifters of aggregate demand change in c onsumer spending...
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NATIONAL INCOME AND PRICE DETERMINATION
Shifters of Aggregate Demand
Change in Consumer Spending
Change in Investment SpendingChange in Government Spending
Net EXport Spending
AD = C + I + G + X
Shifters of Aggregate SupplyAS = I + R + A + P
Change in Resource PricesChange in Actions of the GovernmentChange in Productivity (Investment) 2
Change in Inflationary Expectations
BA
D
A
D
B
A
A
C A major increase in productivity.A
Answer and identify shifter: C.I.G.X or I.R.A.P
3
Putting AD and AS together to get Equilibrium Price Level and Output
4
How does this cartoon relate to Aggregate Demand?
5
• Macroeconomic equilibrium occurs at the intersection of aggregate demand and short-run aggregate supply.
**Handout
It can also happen that this
occurs at the long-run equilibrium point, but not necessarily.A
ggre
gate
Pric
e Le
vel
Aggregate Output
LRASSRAS
AD
• As we have learned a Demand Shock can effect equilibrium: (demand shocks are shifts in the AD curve and Supply shocks are shifts in the SRAS)
Shocks
• Demand shock causes Ag. Price Level and Ag. Output to move in the same direction
• Supply Shock causes them to move in opposite directions
Shocks cont.
• Demand shocks have short-run effects on Ag. Output because the economy is self-correcting in the long run
• In a recessionary gap, an eventual fall in nominal wages moves the economy to long-run equilibrium (wages are sticky—slow to move-- in the SR)
• In an inflationary gap, an eventual rise in nominal wages moves the economy to long run equilibrium
To sum it up…Shocks cause a shift in the Aggregate Demandor Supply and can also lead to
Recessionary Gaps orInflationary Gaps or
Stagflation Stagflation is inflation and falling output
and is caused by a negative supply shock
What’s it look like?
Price Level
14
AS
Inflationary Gap
GDPR
LRAS
QY
AD1
PL1
Q1
Output is high and unemployment is less than NRU
Actual GDP above potential
GDP
Price Level
15
AD
AS
Example: Assume the government increases spending. What happens to PL and Output?
GDPR
LRAS
QY
AD1
PLe
PL1
Q1
PL and Q will Increase
Price Level
16
AD
GDPRQY
PL1
Q1
LRAS AS1
Recessionary Gap
Output low and unemployment is more than NRU
Actual GDP below potential
GDP
Price Level
17
AD
AS
GDPRQY
PLe
PL1
Q1
LRAS AS1
StagflationStagnate Economy
+ Inflation
Example: Assume the price of oil increases drastically. What happens to PL and Output?
What about the long run?
Baby Steps
Price Level
19
AD
AS
Assume the government increases spending. What happens to PL and Output?
GDPR
LRAS
QY
AD1
PLe
PL1
Q1
PL and Q will Increase
Price Level
20
AD
AS
Now, what will happen in the LONG RUN?
GDPRQY
AD1
PLe
PL1
Q1
LRAS
Inflation means workers seek higher wages and production costs increase
AS1
PL2
Back to full employment with higher price level
Price Level
21
AD
AS
Assume consumers increase spending. What happens to PL and Output?
GDPR
LRAS
QY
AD1
PLe
PL1
Q1
Price Level
22
AD
AS
Now, what will happen in the LONG RUN?
GDPRQY
AD1
PLe
PL1
Q1
LRAS
Inflation means workers seek higher wages and production costs increase
AS1
PL2
Back to full employment with higher price level
Supply shocks and demand shocks can cause recessions
Long Term Equilibrium
• To summarize how an economy responds to recessions/inflation we focus on Output Gap which is the % difference between actual aggregate output and potential output. Actual Aggregate Output-Potential Output x 100
Potential Output
In the Long Run the economy is self-correcting but many times Governments are not willing to wait that long which brings about Macroeconomic Policy