Module 5 LRAS and AD

Module 5 - Basic Macroeconomic Models: Long-Run Aggregate Supply & Aggregate Demand

General Course Information

  • Instructor: Dr. Justin Barnette

  • Course: Econ B252: Fundamentals of Economics for Business II

Announcements

  • Check announcements in Canvas.

  • Review due dates in syllabus.

  • Textbook chapters provide more details.

  • Contact your assistant for grade and attendance issues (contact information located in syllabus).

Module Outline

  • Long-Run Aggregate Supply Curve

  • Long-Run Aggregate Supply and Economic Growth

  • Aggregate Demand Curve

  • Shifts in the Aggregate Demand Curve

  • Long-Run Equilibrium: Prices, Output & Employment

  • Explaining Changes to Prices, Output & Employment

  • The Classical Model: Long-Run

Learning Objectives

  1. Define and illustrate long-run aggregate supply and relate it to the production possibilities curve (PPC).

  2. Identify, apply, and illustrate the determinants of long-run aggregate supply and their relation to long-run economic growth.

  3. Define and illustrate aggregate demand and relate it to the expenditure approach.

  4. Identify, apply, and illustrate the determinants of aggregate demand, distinguishing between changes in aggregate demand versus changes in aggregate quantity demanded.

  5. Analyze the effects of changes in long-run aggregate supply and/or aggregate demand on long-run equilibrium concerning prices (inflation), output (real GDP growth rate), and employment.

  6. (Not covered in this session)

Learning Objective #1: Long-Run Aggregate Supply and Production Possibilities Curve (PPC)

  • Definition of Long-Run Aggregate Supply (LRAS):

    • Represents the total output of an economy when all resources are fully employed, including:

    • Labor

    • Physical Capital

    • Other Resources

    • Characteristics:

    • Sustainable production levels at full employment.

    • The price level does not affect LRAS.

Visual Representation of LRAS

  • Graph: Shows the vertical LRAS curve where real GDP is plotted against price levels.

  • Indicates:

    • Markets are in equilibrium.

    • All prices adjust; no change in output.

    • Unemployment is at the natural rate, thus reflecting full employment.

    • LRAS signifies potential GDP, not the maximum GDP level.

Learning Objective #2: Determinants of Long-Run Aggregate Supply (LRAS) Growth

  • Long-run growth is exhibited by outward shifts of the LRAS curve caused by:

    • Increases in Labor (L)

    • Increases in Capital (O)

    • Advances in Technology (P)

    • Improvements in Productivity (P)

    • Enhancements in Human Capital (E)

Economic Implications of Price Level Changes on Economic Growth

  • If the price level increases:

    • Potential GDP may increase or remain constant while prices rise, depending on other contributing factors.

Learning Objective #3: Aggregate Demand and Expenditure Approach

  • Definition of Aggregate Demand (AD):

    • Total planned expenditures in the economy, calculated by:
      AD=C+I+G+NXAD = C + I + G + NX
      where:

    • C = Consumption

    • I = Investment

    • G = Government Spending

    • NX = Net Exports

Characteristics of the Aggregate Demand Curve

  • Depicts planned purchase rates for all goods and services at various price levels.

  • Inverse relationship: as the price level rises, real GDP demand declines.

Learning Objective #4: Determinants and Shifts in Aggregate Demand

Shifts in the Aggregate Demand Curve

  • Non-price-level changes can shift the Aggregate Demand curve:

    • Rightward Shift (Increase in AD):

    • Improvements in economic conditions abroad.

    • Decreased currency value.

    • Increased job security or future income expectations.

    • Reduction in real interest rates.

    • Tax decreases.

    • Increased money circulation.

    • Leftward Shift (Decrease in AD): Opposite factors leading to reduced domestic spending.

Learning Objective #5: Analysis of Equilibrium Effects

Long-Run Equilibrium Dynamics

  • Equilibrium Point: Intersection of AD and LRAS indicates:

    • Equilibrium price level where real expenditures equal potential production.

  • Changes in LRAS:

    • When LRAS shifts from one year to another:

    • Example: Shift from LRAS2024 to LRAS2025 results in decreases in price levels but increases in Real GDP.

Inflation Causes

  • Inflation can be attributed to:

    • Supply constraints or demand increases, illustrated using demand and supply movements on the AD-LRAS graph.

Graphical Analysis of Economic Models

  • AD-LRAS Model Summary:

    • Various shifts and their implications on equilibrium, potential GDP, and price levels are essential for understanding economic forecasts and conditions.

Practical Application and Case Studies

Infrastructure Investment Example

  • A city enacts a plan to improve infrastructure in 2025:

    • How this will impact AD and LRAS curves:

    • Potential GDP will likely rise; the long-run price level impact could vary depending on monetary policy and external economic conditions.

Assessing Supply Chain Impact

  • Disruptions in supply chains can shift both potential GDP and price levels, demanding rigorous analysis for prediction.

Additional Notes

  • Refer to St. Louis Fed Blog on inflation for continuous updates and nuances in economic trends.

  • Remember the format for assessment preparation and ensure solid understanding of core concepts as articulated in syllabus and learning resources.