ch.9 Aggregate demand and supply

origin of macro economics

industrial capacity was unused; unemplyment wsa high; businessed were not investing

the aggregate demand curve shows the output of goods and services (real gdp) purchased at different price levels

aggregate demand

a higher aggregate price level causes lower aggregate output

aggregate demand slopes down due to the wealth effect, export price effect, and interest rate effect

(on graph: shifts outward to the right at an upward angle)

wealth effect AGGREGATE DEMAND

as prices rise, the purchasing power of wealth falls, reducing consumption

export price effect AGGREGATE DEMAND

as prices rise, exports become more expensive, and exports drop

interest rate effect AGGREGATE DEMAND

as prices rise, people hold more money, pushing interest rates higher, reducing business investment

Determminants of aggregate demand

factors that shift the entire aggregate demand curve: consumer spending, investment, government spending, net exports

shifts in aggregate demand

when AD shifts to the right, output increases at every price level

spending affected by: wealth, consumer confidence, household debt, interest rates

investments are determined by interest rates, expected rate of return on investment, and business expectations

Government spending is determined by Federal, state, and local lawmakers

net exports are determined primarily by foreign income and exchange rates

aggregate supply curve shows the real GDP that firms will produce at various price levels

Long-run aggregate supply

vertical

incorporates the approach of classical economic analysis, which assumed that all factors are variable in the long run(economy will automatically adjust to full employment)

Long-rub aggregate supply (LRAS)

a shift in the long-run aggregate supply curve moves the economy to a new long-run equilibrium output

shifts rightward

shifting the LRAS curve

depends on economy’s capacity and can shift due to: discovery of new resources, improvements in the quality of the labor force, technological improvements and automation, international trade and investment

corresponds to output at full employment and take time to adjust

Short-run aggregate supply (SRAS)

the aggregate supply curve is upward sloping: some input prices are slow to change they are “sticky”; when prices rise but input prices are sticky, profit increases and form produce more, results in a short-run increase in aggregate output

short-run aggregate supply

SRAS is positively sloped because input costs are slow to change (they are sticky)

determinants of SRAS

input prices, technology and productivity, taxes and regulation, market power of firms, inflationary expectations

shifts of the SRAS curve

a factor that causes SRAS to shift to the right results in an increase in aggregate output at every price level

input prices (such as steel) can lead to the short-run aggregate supply curve shifting to the left

rising productivity increases profit and increase short-run aggregate supply

taxes and regulation add to the costs of business, causing the SRAS curve to shift leftward

as industries become more concentrated (firms have more market power), SRAS decreases

Macroeconomic equilibrium

short-run macroeconomic equilibrium occurs where AD and SRAS intersect

long-run macroeconomic equilibrium occurs where AD and LRAS intersect

short-run equilibrium (inflation)

short-run equilibrium above full employment indicates an economy experiencing inflationary pressures

short-run equilibrium (recession)

short-run equilibrium below full employment indicates an economy experiencing a recession

the spending multiplier

magnifies new spending into higher income and output. each round of spending becomes income to someone else:

mulitplie = 1/(1-MPC)

ex: MPC = 0.6 mulitiplier = 1/(1-0.6)=2.5

a $100 increase in new spending generate $250 in aggregate output

the multiplier and AD-AS

when short-run equilibrium is below full employment, the spending multiplier magnifies new spending, shifting AD toward long-run equilibrium

demand pull inflation

a positive demand shock expands the economy beyond full employment output

higher input prices shift SRAS to the left until long-run equilibrium is restored at Q but at a higher price level

cost-push inflation

a negative supply shock reduces output and raises prices. increasing AD will push output back to full employment but at even higher prices. Decreasing AD will reduce inflation but increasesupply disruptions

supply disruptions from 2020 to 2022 lead to a leftward shift of the SRAS curve resulting in a higher price level

WHICH OF THE FOLLOWING DOES NOT OCCUR WHEN THE AGGREGATE PRICE LEVEL DECREASES?
A. INTEREST RATES DECREASE
B. PURCHASING POWER INCREASES
C. VALUE OF MONEY ASSETS DECREASES
D. EXPORTS INCREASE
E. AGGREGATE OUTPUT INCREASES

c. value of money assets decreases