aggregate demand and supply

aggregate demand

sum of all demand within an economy

same as GDP

aggregate demand graph

components of aggregate demand

consumption, investments, government spending (except transfer payments), exports minus imports

consumption

all goods and services purchased by households

investments

all investments made by firms and households

government spending

all money spent by government (excluding transfer payments)

exports

goods produced in one country and sold to another

imports

goods produced by another country and then bought and brought

causes of change in consumption

changing incomes, changes in wealth, consumer expectation and confidence, household debt, interest rates

causes of change in investments

lower interest rates, rise in national incomes, business confidence, technology change

causes of change in government spending

spending on infrastructure, correcting market failure, war

causes of change in net exports

rise in foreign incomes could result in a rise in exports, strong currency could result in less exports, tariffs would reduce exports, high inflation would reduce exports

determinant of exchange rate in a country

supply and demand

if there is a demand for the currency, it will get stronger

you have demand for a currency when you buy goods from that country, invest in a business in that country, put money in financial institutions of that country

how do governments encourage consumption

increase incomes > lower taxes

affect interest rates > buy bonds increasing money supply

increase wealth > redistribute wealth through progressive taxes

decrease household debt > forgive student loans

aggregate supply

total amount of goods and services that all industries in the economy will produce at a given price

aggregate supply graph

long run aggregate supply (new classical)

supply and output stays the same

demand can change and leads to price changes

employment and output don’t change

assumes that producers will always produce at a level in which all resources are employed

presumes wages and prices are flexible

government intervention will not help and the economy will self correct itself

short run aggregate supply (new classical)

only new classical economists believe in this

period in time when the factors of production do not change

wage rate is fixed

to meet an increase in demand, suppliers will have to offer incentives, such as overtime pay

costs go up as supply goes up

shifts in short run aggregate supply

WRISST

changes in wage rates

changes in cost of raw materials

supply shock

subsidies and taxes

changes in wage rates

shift in short run aggregate supply

if wages go up, the SRAS will shift left

if wages go down, the SRAS will shift right

changes in cost of raw materials

shift in short run aggregate supply

if the cost of raw materials go up, SRAS will shift left

if the cost of raw materials go down, SRAS will shift right

supply shock: covid, flood, war

shift in short run aggregate supply

if supply shocks occur, SRAS will shift left

if supply shocks dont occur, SRAS will stay the same

subsidies and taxes

shift in short run aggregate supply

if subsidies are given, SRAS will shift right

if taxes are imposed, SRAS will shift left

decrease in AD (new classical)

demand shifts left which causes prices to deflate workers will (eventually) accept lower wages

there is no unemployment (unless its voluntary)

costs go down (prices and wages)

SRAS shifts to the right

because wages and costs are lower, so are prices

economy will always self correct

wages have gone down but real wages are the same because costs always go down

new classical opinion on government intervention

unemployment benefits, minimum wages, price controls, and trade unions are harmful to the economy because they set boundaries upon wages, prices, and costs and don’t allow the economy to self correct

don’t believe in government intervention

increase in AD (new classical)

demand shifts to the right causing price inflation

firms compete to higher workers to keep up with demand, pushing wages and costs up

firms lay off workers and output declines (SRAS shifts left)

only the price level increases (inflation) with an AD increase

SRAS shifts to the left because wages and costs go up

if the government increases spending to help the economy/shift SRAS to the right, it will only be inflationary and not help with growth

Keynesian theory

believes that wages and prices will not easily go down

people won’t take pay cuts

at a certain point increasing AD will not cause growth but AS increases growth in an economy

keynes graph

1. resources are under utilized
2. everyone that wants a job has a job
3. increase in demand is purely inflationary

decrease in AD (keynesian)

shift to the left

firms must lay off workers since wages are sticky

output falls, unemployment increases

deflation will be slight, or non existent (prices slip a bit)

happens because people refuse to take a pay cut

the economy will slip into a recession

requires government intervention to fix itself

keynesian opinion on government intervention

unemployment benefits, minimum wages, and government spending are helpful in a recession because it stops other people from being unemployed and keeps the economy stable and prevents outputs from falling

government intervention is required

increase in ad (keynesian)

employment and output will increase

prices will remain stable

eventually at full capacity, prices will begin to inflate

finally, an increase in demand will be “purely inflationary”

purely inflationary- prices keep going up