Output and the Exchange Rate in the Short Run...

Output and the Exchange Rate in the Short Run CHAPTER ORGANIZATION Introduction Aggregate Demand and Aggregate Supply: A Review Determinants of the Current Account Exchange Rate Changes and Equilibrium Output in an Open Economy Summary INTRODUCTION How can we analyze the short-run of an open economy? What are the impacts on a country’s imports and exports from changes in the real exchange rate? Present a general model of output and price determination in an open economy How much effect do changes in foreign trade have on growth rate of GDP? What is the importance of the real exchange rate in an open economy? Its effect on output and output composition? AGGREGATE DEMAND AND AGGREGATE SUPPLY: A REVIEW Aggregate Demand Aggregate demand is the relationship between total quantity demanded of goods and services in all sectors of the economy and the price level, holding all else constant The axis are total output of goods and services measured by real GDP and the price level measured by GDP price deflator The aggregate demand curve slopes downward to the right AGGREGATE DEMAND AND AGGREGATE SUPPLY: A REVIEW Figure 17.1 The Aggregate Demand Curve Price Level (P) B P1 A P0 Aggregate Demand (AD) Y1 Y0 Real GDP (Y) AGGREGATE DEMAND AND AGGREGATE SUPPLY: A REVIEW The aggregate demand curve does not behave in the same manner as an ordinary demand curve If the price of a single product falls, the consumer’s real income rises increasing the amount consumed for a normal good (income effect) The lower price induces consumers to purchase more of the product because it’s cheaper (substitution effect) Neither the income or substitution effect are relevant to overall price level AGGREGATE DEMAND AND AGGREGATE SUPPLY: A REVIEW If the aggregate price level falls, prices consumers pay are falling and prices people receive as wages, rents, etc. are falling Therefore, there is no income effect (no change in demand as the price level falls) The price level...