Macro. Ex 3 - March 20 lecture notes

  • Introduction to Aggregate Demand and Supply

  • Focus for the semester on aggregate demand and aggregate supply.

  • Definitions:

    • Aggregate Demand (AD): The total demand for all goods and services in an economy.
    • Aggregate Supply (AS): The total supply of goods and services in an economy.

  • The model resembles traditional supply and demand but differs in significant ways.

  • Aggregate Demand Curve

  • Vertical axis measures overall price level, not specific goods.

  • Examples of price indices: Consumer Price Index (CPI), GDP deflator, which set base years (e.g., 02/2012 = 100).

  • AD Curve is downward sloping, indicating an inverse relationship between price level and quantity demanded.

  • Aggregate Supply Curve

  • Short-Run Aggregate Supply (SRAS) curve is upward sloping.

  • Long-Run Aggregate Supply (LRAS) is vertical, indicating full employment output.

    • Equilibrium: Occurs where AD, SRAS, and LRAS intersect. This intersection determines the equilibrium price level (P*).

  • Full Employment Output

  • Full employment doesn’t imply zero unemployment; cyclical unemployment is zero at full employment.

  • Includes structural and frictional unemployment.

  • Price Levels and Output Changes

  • In the short run, price level changes can affect output; in the long run, LRAS remains unchanged as it’s vertical.

  • Economic growth can shift LRAS to the right, stagnation can shift it left.

  • Macroeconomic Equilibrium and Components

  • Relationship illustrated with the equation: Y = C + I + G + NX (where C = consumption, I = investment, G = government spending, NX = net exports).

  • Shifts in Aggregate Demand Curve

  • Factors shifting AD include government policy changes, consumer and firm expectations, and net exports.

  • Government Policies:

    • Monetary Policy:
    • Actions by the Federal Reserve to influence the economy, primarily by changing interest rates.
    • Lower interest rates to stimulate spending (in recession) or raise them to cool inflation.
    • Tools include open market operations (buying/selling bonds) and adjusting reserve requirements.
    • Fiscal Policy:
    • Government decisions on taxation and spending can shift AD via altering disposable income or government purchases.
    • Lowering taxes or increasing spending can shift AD right; increasing taxes or cutting spending can shift AD left.

  • Expectations Impacting Demand

  • Positive expectations shift AD to the right; negative expectations shift it left.

  • Households and firms’ optimism or pessimism about future income affects consumption and investment decisions.

  • Net Exports Influencing Demand

  • Decreased exports or increased imports leads to a decrease in net exports, shifting AD left.

  • The value of the dollar affects net exports; a more valuable dollar decreases exports and increases imports.

  • Aggregate Supply Curve Differences

  • Short-Run Aggregate Supply (SRAS):

    • Upwards sloping; output can change with price changes.

  • Long-Run Aggregate Supply (LRAS):

    • Vertical; not affected by price level changes.
    • Factors influencing both curves include labor force, capital stock, and technology.

  • Shifting the Short-Run Aggregate Supply

  • Any increase in production costs shifts SRAS left; decreases shift it right.

  • An increase in workers, capital, or technological advancements shift both curves right.

  • Expected Changes in Price Level

  • If price levels are anticipated to increase, both wages and prices will rise, shifting SRAS left.

  • If less inflation is expected, firms and workers will accept lower prices/wages, shifting SRAS right.

  • Dynamic Aggregate Demand and Supply Model

  • In real-time scenarios, the LRAS typically shifts right, representing economic growth.

  • Three potential outcomes:

    • Price level remains constant while all curves shift right.
    • AD shifts more than AS, leading to inflation.
    • AD shifts less than AS, potentially leading to deflation.

  • Graphical Representations

  • Use distinct labels for curves and intersections to clearly illustrate shifts and equilibria in exam responses.

  • Practice drawing scenarios where AD and SRAS vary to solidify understanding of recession versus inflation contexts.

  • Conclusion

  • Understanding the aggregate demand and supply curves, along with factors that shift them, is crucial to analyze macroeconomic conditions and policy impacts.