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What does the AE curve shift in response to?
Exogenous changes in the price level. Price level meaning the average price of all the goods and services in the economy.
How does a shift in the AE curve occur?
The shift occurs because a change in the price level affects desired consumption expenditures and desired net exports,
What does a change in the price level also change?
Changes in price level also cause a change in consumption.
What does the relationship between price level and consumption have to do with? How are they related?
The relationship between the price level and desired consumption has to do with how changes in the price level lead to changes in household wealth and thus changes in desired spending.
In what form is wealth held in the private sector?
In the form of assets with a fixed nominal value. its current price which is constant unlike a market price which fluctuates.
What does the purchasing power of money depend on?
What money can buy- or its real value- depends on the price level.
Rise in domestic price levels lowers the value of money holdings. Fall in domestic price levels raises the real value of money.
Examples of assets that have fixed nominal values
Government and corporate bonds.
Changes in price levels and how it relates to purchasers and issuers of bonds.
A rise in the price level means that the repayment to the lender is lower in real value than it otherwise would be (a decline in wealth for the lender). However the issuer of the bond will have made a lower repayment because of the increase in price level.
Changes in the price level change the wealth of bond purchasers and bond issuers, but because the changes offset each other, there is no change in aggregate wealth.
What happens when domestic price levels rise?
Canadian goods become more expensive relative to foreign goods.
What happens to consumerism when price level increases?
Since Canadian goods are more expensive relative to international prices, Canadians will buy less C Canadian goods and buy more foreign items which are less expensive to them. At the same time international people will also buy less from Canada, reducing net exports.
What happens to AE curve when price level rises
A rise in the domestic price level (with a constant exchange rate) reduces net exports and causes a downward shift the in AE curve. A fall in the domestic price level increases net exports and causes an upwards shift in the AE curve.
What does an exogenous rise in price level cause a downward shift in the AE curve?
Because it reduces both desired consumption and desired net exports. Causing the equilibrium level of real GDP to fall.
What does an AE curve look like? depict the graph when price level increases.
AE on y axis, real gdp on x axis, and the AE shifting down.
What happens when there is a fall in the price level?
Canadian goods become cheaper relative to international goods, net exports rise cause both Canadians and international people are buying from Canada as opposed to other places. Causing AE to shift upwards.
What happens to purchasing power and GDP level when price level falls?
The purchasing power of nominal assets increase so households can spend more, since AE is going upwards the equilibrium level of real GDP rises.
What is an aggregate demand curve?
A curve showing combinations of real GDP and the price level that make desired aggregate expenditure equal to actual income.
Draw the graph of an AE curve and its corresponding AD curve showing price. Show when price level increases what it looks like.
price level is bottom of AE curve, on the y-axis. AD curve is negative sloped in comparison to positive sloped AE curve.
Equilibrium GDP and AE/AD curve
Equilibrium GDP is determined by the AE curve for each given price level.
The level of GDP and its associated price level are then plotted to yield a point on the AD curve.
What does changes in the price level cause graphically for the AE and AD curve?
Since AD curve related equilibrium GDP to the price changes....
Changes in price cause
SHIFTS in the AE curve
and
MOVEMENTS along the AD curve.
What does a rise in price level cause for AD and AE?
AE curve shifts downward
AD curve moves upward and to the left along the graph. = Fall in equilibrium GDP.
What does a fall in price level cause for AD and AE?
AE curve shifts upward
AD curve moves downward and to the right along the graph.
= Rise in the equilibrium GDP.
What is the underlying logic for the negative slope of the AD curve.
1. A fall in the price level leads to a rise in private-sector wealth, increasing desired consumption and equilibrium GDP.
2. A fall in the price level (for a given exchange rate) leads to a rise in net exports and increase in equilibrium GDP.
What can cause the AD curve to shift?
For a given price level, any event that leads to a shift of the AE curve which directly changes equilibrium GDP.
What are some of the changes that cause AD curve to shift?
A change in any of the autonomous variables that cause the AE curve to shift.
- desired consumption
- government purchases
- desired investments
- net exports
Aggregate Demand Shock
Any change (other than price level changes) that causes the AE curve to shift that will also cause the AD curve to shift.
What does the simple multiplier measure in terms of the AD curve?
The simple multiplier measures the resulting horizontal shift in the AD curve.
simple multiplier and shifts in the AD curve.
For a given price level, an increase in autonomous aggregate expenditure shifts the AE curve upward and the AD curve to the right. A fall in autonomous aggregate expenditure shifts the AE curve downward and the AD curve to the left.
IMPORTANT MIST KNOW ABOUT AD CURVE
To shift the AD curve, the change in autonomous expenditure must be caused by something other than a change in the domestic price level. Because a change in the domestic price level only leads to a movement along AD curve not a shift.
simple multiplier and AD curve
The simple multiplier measures the horizontal shift in the AD curve in response to a change in autonomous desired expenditure.
Price level and simple multiplier
If the price level remains constant and producers are willing to supply everything that is demanded at that price level, the simple multiplier will also show the change in equilibrium GDP that will occur in response to a change in autonomous expenditure.
Aggregate Supply Curve
A curve showing the relation between the price level and the quantity of aggregate output supplied, assuming the constant factors of prices and technology.
What are the two main assumptions for an AS curve?
- Factor prices are constant
- state of technology is constant
Unit costs
Costs per unit of output, equal to total cost divided by total output
How will unit costs change if the firm attempts to increase their level of output?
As output increases, less efficient standby plants may have to be used, and less efficient workers may have to be hired, while exitsing workers may have to be paid overtime rates for additional work. Therefore, unit costs tend to rise as output rises when if tech and prices stay constant.
law of diminishing returns
When additional units of a variable input are added to fixed inputs after a certain point, the marginal product of the variable input declines.
What leads to the positive slope of the AS curve?
The positive relationship between output and unit costs. (when unit costs increase its cause output is increasing).
Firms will provide more aggregate output only at a higher price level.
What do firms have to do to make more profit and increase their output.
Firms who are interested in increasing their profits (and avoiding losses) will not be prepared to produce and sell more output unless they are able to charge a higher price sufficient to cover their unit costs.
draw aggregate supply curve
price on y-axis, real GDP on x-axis. Positively sloped.
what does the flat part and the steep part of the AS curve indicate?
The higher the level of output, the faster unit costs tend to rise with each extra increment to output.
Curve becomes steeper as output rises but at low levels of outputs since firms can have excess capacity, increases in output may not drive up unit costs yet.
What are the higher-cost production methods that have to be adopted as output is pushed above normal capacity?
standby capacity, overtime, extra shifts.
Shifts in the AS curve
Since AS curve is drawn for a given set if factor prices and a given state of technology, anything that leads to a change in these variables will cause a shift in the AS curve. Hence firms require a different price level to provide the same level of output.
Aggregate supply shocks
Changes to factor prices and technology that are exogenous to our macro model. Any shift in the AS curve caused by an exogenous force.
How do firms produce goods and services?
Firms use factors of production as inputs, including various types of land, labour, and physical capital.
factor prices
The prices firms pay for input factors. When factor prices change, the AS curve shifts.
What happens if factor prices rise?
Firms' profits at the current level of output are reduced.
How do firms respond to a reduction in profits due to factor prices rising?
1. maintaining their current level of output, in which case they require an increase in the price level.
2. Reducing their level of output if the price level does not change.
In either case, the AS curve shifts upward and to the left. This is a decrease in aggregate supply.
When can the AS curve shift upwards and the left?
When anything increases a firms' costs and the aggregate supply decreases.
What does it mean when AS curve shifts upwards?
It means there are higher production costs, supply shocks, and decreased productivity.
Can also lead to stagflation.
What does it mean when AS curve shifts downwards?
Decreased production costs, positive supply shocks, increased productivity, and economic growth with stable or falling answers.
What would increase a firms unit costs?
A rise in factor prices and a deterioration in technology.
What is a reduction in aggregate supply?
When the AS curve has shifted up or to the left from AS0 to AS1.
What causes the AS curve to shift down (rightwards)?
An increase in aggregate supply, meaning a fall in factor prices or an improvement in technology. Because a fall in factor prices makes production more proditable and causes the AS curve to shift down. Meaning there will be more output supplied at each price level.
Raw materials and AS curve
Raw materials are important inputs to the production process and changes in their prices may also cause shifts in the AS curve.
What are examples of negative supply shock that causes the AS curve to shift upward and towards the left?
Increase in factor prices and other input prices.
What are examples of positive supply shock that causes the AS curve to shift downwards and towards the right?
Decreases in factor prices and other input prices
What does an improvement in technology ensue?
Any change to production methods that reduces units costs for any given level of output.
What do improvements in technology lead to?
Leads to typically lower prices as competing firms cut prices in attempt to raise their market share. Since same output is being sold at lower prices, the AS curve shifts downwards.
What does a deterioration in technology mean?
Any change in production methods that raises unit costs for any given level of output.
What can a deterioration in technology lead to?
Since firms are unlikely to intentionally adopt new methods that raise their costs, the latter occurrences are rare, However, this can happen for industries like specific weather conditions.
exogenous
Produced outside the body
Endogenous
Produced within the body
Where does the equilibrium values of real GDP and the price level occur?
At the intersection of the AD and AS curve.
What is macroeconomic equilibrium?
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 AS curve.
Draw a macroeconomic equilibrium graph
AS/AD model with AD a negative slope and AS a positive slope. price on y-axis, and real GDP on x-axis.
Where are demand behaviour and supply behaviour consistent?
Only at the combination of real GDP and price level.
What are the two conditions that must be satisfied?
1. Desired aggregate expenditure must be equal to actual GDP. This is fulfilled by AD curve.
2. at the prevailing price level firms must want to produce the prevailing level of GDP. This is fulfilled by AS curve.
Only when these two cross are both conditions fulfilled at the same time.
Positive demand shock
A rightward shift in the AD curve is an increase in desired aggregate spending.
Negative demand shock
a leftward shift in the AD curve is a decrease in desired aggregate spending at any given price level.
Aggregate supply shock
a shift in the AS curve caused by an exogenous force.
Positive supply shock
A rightward shift in the AS curve is an increase in aggregate supply at any given price level. more real GDP will be supplied.
negative supply shock
A leftward shift in the AS curve is a decrease in aggregate supply at any given price level, less real GDP will be supplied.
AD and demand shocks
Aggregate demand shocks cause the price level and real GDP to change in the same direction; both rise with an increase in aggregate demand and both fall with a decrease in aggregate demand.
The multiplier when the price level is constant
Determines the size of the horizontal shift in the AD curve in response to a change in autonomous expenditure. Determining the increase in equilibrium GDP.
The simple multiplier when the price level varies
The change in real GDP is no longer equal to the size of the horizontal shift in the AD curve. Part of the expansionary impact is offset by a rise in price level, but an increase in output still occurs but its not represented by the simple multiplier anymore.
Why is the multiplier smaller when the AS curve is positively sloped?
Price level increases absorb a portion of the increase in spending, the cost-push effects on production, reduced real wealth effect.
Draw an AE and AS/AD graph with an increase in price
AE: top, AE is the y-axis, GDP is x-axis, with 45 line. first goes really up and the offsets so it goes to middle.
AS/AD: price is y-axis, GDP is x-axis, AD moves towards the right. first goes really far right but then moves back towards the AS.
AE and AS/AD model
An increase in autonomous expenditure causes the AE curve to shift upward, but the rise in the price level causes it to shift part of the way down again. Making the multiplier smaller than when the price level is constant.
First movement of the AD curve in an increase in autonomous expenditure macro graph
The movement is the horizontal shift of the AD curve and is equal to the simple multiplier times the change in autonomous expenditure.
aggregate demand shock leads to a change in price level....
Ultimate change in real GDP will be less than what is predicted by the simple multiplier, in other words, a variable price level reduces the value of the multiplier.
The effects of increases in aggregate demand
The effect of any given shift in AD will be divided between a change in Y and a change in P
The steeper the AS curve, the greater the price effect and the smaller the output effect.
The division of effect on an aggregate demand graph when there is an increase in AD
The effect of any given shift in AD will be divided between a change in real GDP and a change in the price level, depending on the conditions of aggregate supply. The steeper the AS curve, the greater the price effect and the small the GDP effect.
What happens to price level as the AD graph moves higher up the AD graph?
Virtually all of the effect is on the price level and not the output/GDP.
Flat range of a MacroEq graph
The keynesian range of AS curve, any aggregate demand shock leads to a change in equilibirum GDP not change in price level--> cause of excess capacity. (can use simple multiplier).
Intermediate range of a MacroEq graph
Positive slope range --> a shift in the AD curve gives rise to appreciable changes in both real GDP and the price level. (positive but smaller than simple multiplier).
Steep range of a MacroEq graph
Very little more can be produced no matter how large the increase in demand is. Deals with physical capacity constraints.
Any change in aggregate demand leads to a sharp change in the price level and little to no change in real GDP. Multiplier is nearly zero.
In the case of a vertical AS curve...
AD shocks will result in no change in real GDP but only a change in price level.
What is an example of a negative AS shock?
increase in factor prices, or a deterioration in tech, leading to higher firms costs. leading to upward shift in teh AS curve.
Example of positive AS shock
decrease in factor prices, improvement in tech. moving downward or rightward shift in the AS curve.
Draw a negative supply shock happening
AE on top: AE = y-axis, GDP = x-axis, E0 moves to E1 down.
causing price to move up.
AS on bottom: price level = y-axis, GDP = x-axis, AD negative slope, AS positive slope, since negative moves supply up, it ends up bringing a new E1 point at a higher price point.
AS shocks and relationship with price level and GDP
AS shocks cause the price level and real GDP to move in opposite directions. With an increase in supply, the price level falls and GDP rises, with a decrease in supply, the price level rises and GDP falls.
Stagflation
a period of slow economic growth and high unemployment (stagnation) while prices rise (inflation). Real GDP falling while price levels rose.
Analyze the pandemic with the AS/AD model.
1. make distinction between supply side and demand side
2. Supply side: Since not any more workers, the technology has deteriorated, a negative shock will cause AS to move upwards and to the left.
3. Demand side: reduction in demand for an unchanged level of income, so negative AD shift towards the left, making real GDP fall.
4. Combined effect of negative AS and AD shock = sharp reduction in output and employment.
Changes in the world prices of raw materials.
Especially changes in the world prices of raw materials cause both aggregate demand and aggregate supply shocks in the same economy. The overall effect on real GDP in that economy depends on the relative importance of the two separate effects.
EX: Canada and world price of oil decreasing.
