UNIT 3 Macroeconomics Aggregate Demand + Supply, Multipliers, Long Run/Short Run

Aggregate

Added all together

Aggregate demand

All goods and services buyers are willing and able to purchase. (real GDP)

Inverse relationship between price level and real GDP.

AD = C + I + G + NE

Aggregate demand curve

Downward sloping curve of demand by consumers, businesses, government and foreign countries.

Reasons for downward slope of AD curve

1.) Real balance effect

2.) Interest rate effect

3.) Foreign trade effect

Real balance effect

Higher price levels reduce purchasing power, decreases quantity of expenditures.

Interest rate effect

With price level increases, lenders need to charge higher interest rates to get a real return, high interest rates discourage expenditures.

Foreign trade effect

U.S. price levels rising, foreign buyers purchase fewer U.S. goods and Americans buy more foreign goods.

Shifters of aggregate demand

1.) Change in consumer spending

2.) Change in investment spending

3.) Change in government spending

4.) Change in net exports

Examples of change in consumer spending

• Consumer wealth (boom in stock market)

• Consumer expectations (fear of recession)

• Household indebtedness (more consumer debt)

• Taxes (decrease in income taxes)

Examples of change in investment spending

• Real interest rates

• Future business expectations

• $ spent on productivity and technology

• Business taxes

Examples of change in government spending

• War, changes in defense spending

• Nationalized healthcare

Examples of change in net exports

• Exchange rates

• National income compared to abroad

Government Influence of AD

Fiscal and Monetary policy

Fiscal policy

Government transfer payments, tax and transfer payment policies.

Monetary policy

Involves use of changes in the money supply and consequently changes in the interest rate.

Short Run aggregate supply (SRAS)

All the goods and services that firms are willing and able to produce at various price levels.

Price level and real GDP are in sync

SRAS curve

Upward sloping due to wages and resource prices not being flexible in the short run. Changes in price level result in movement along the curve.

Shifters of SRAS

1.) Resource prices and availability

2.) Actions of the government

3.) Productivity and technology

SRAS vs. LRAS

SRAS - wages and resource prices won’t increase with a price level increase

LRAS - wages and resource prices will increase with a price level increase

Long run aggregate supply LRAS

The number of goods and services that an economy is capable of producing with the full employment of resources. Relationship between price level and real GDP output is constant

LRAS curve

Will be vertical at full employment. If it shifts left, the economies ability to produce will decrease, and if it shifts right the economies ability to produce will increase.

Shifters of LRAS

(The same as PPC shifters)

1.) Number of resources

2.) Quality of resources

3.) Technology

4.) Government policy

Multiplier effect

The idea that an initial change in spending will set off a spending chain that is magnified in the economy.

Marginal propensity to consume (MPC)

How much people consume rather than save when there is a change in income.

MPC + MPS = 1

change in consumption / change in disposable income

Marginal propensity to save (MPS)

How much people save rather than consume when there is a change in income.

MPC + MPS = 1

change in savings / change in disposable income

Spending multiplier

Number used to identify the total change in spending after initial spending. (Spending chain)

Tax multiplier

Used to determine the maximum change in spending when the government increases/decreases taxes.

MPC / MPS

Proper labeling of AD - AS model

A - axes: price level, real GDP output

C - curves: AD downwards, SRAS upwards

E - equilibrium points

How is equilibrium maintained with a surplus

Prices are lowered.

How is equilibrium maintained with a shortage

Prices are raised.

Long run equilibrium

Occurs when current output is equal to potential output. LRAS curve is on SRAS and AD equilibrium point.

Recessionary gap

Occurs when current output is less than potential output. LRAS curve is to the right of the SRAS and AD equilibrium point.

Inflationary gap

Occurs when current output is more than potential output. LRAS curve is to the left of SRAS and AD equilibrium point.

Demand-pull inflation

Inflation that is caused due to an increase in AD. Results in an increase in both price level and real GDP output.

Cost-push inflation

Inflation that is caused due to a decrease in SRAS. Results in an increase in price level, and a decrease in real GDP output.

Long run self adjustment

Businesses and workers will adjust their price and wage expectations to bring the economy back into equilibrium.

Effects of long run self adjustment

SRAS curve will adjust to meet LRAS and AD curves. LRAS will not shift under self adjustment, will only shift to change in four factors. (land, labor, capital or technology)

Wage rate

The price paid per unit of labor services.

Nominal wage

The amount of money received per hour/day/year.

Real wage

The quantity of goods and services a worker can obtain with nominal wages.

Fiscal policy

Implemented by governments to intervene when the economy overheats/underperforms, speeds up or slows down to bring the economy back to full employment. Can either be government spending or a change in taxes.

Expansionary policy

Used in a recessionary gap, increased government spending has a direct impact on AD, decreased taxes has an indirect impact on AD.

Contractionary policy

Used in an inflationary gap, decreased government spending has a direct impact on AD, increased taxes has an indirect impact on AD.

Self adjustment vs. Fiscal policy

Self adjustment: No government involvement, SRAS curve will move

Fiscal policy: Has government involvement, AD curve will move