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5PTheAggregateDemandandAggregateSupplyModel.pptxThe Aggregate Demand
Aggregate Supply Model
Please listen to the audio as you work through the slides.
Creative Commons Attribution 4.0 License, Charles Hackner Houston Community College unless otherwise noted CC BY NC
Learning objectives
Students should be able to thoroughly and completely explain:
The Aggregate Demand Aggregate Supply Model and how it operates.
The 3 factors supporting its slope of the Aggregate Demand curve, the determinants of the AD curve.
The aggregate supply curve, the 3 time horizons associated with AS, the determinants of the AS curve.
Defined:
Amounts of Real Output Buyers Collectively Desire at Each Possible Price Level.
Aggregate Demand
Aggregate Demand Curve
Downward Sloping Due To:
Real-Balances Effect
Interest-Rate Effect
Foreign Purchases Effect
Aggregate Demand
Aggregate Demand Curve
Downward Sloping Due To:
Real-Balances Effect
Price level changes impact the purchasing power of real balances what are real balances?
Prices rise, real balances fall and spending falls
Aggregate Demand falls
Aggregate Demand
Aggregate Demand Curve
Down Sloping Due To:
Interest-rate Effect
We assume the supply of money fixed
Price level rises, consumers and businesses need more money (demand for money rises).
Price of money (interest rate) rises
Investment spending and interest sensitive consumer spending falls.
Demand for real output falls
Aggregate Demand falls
Aggregate Demand
Aggregate Demand Curve
Down Sloping Due To:
Foreign purchases Effect
US price level rises relative to the rest of the world.
(assumption) Exchange rates not responsive
US exports fall – because?
US imports rise – because?
Price rise causes a drop in demand for US goods demanded as US exports.
Net exports fall
Aggregate Demand falls because?
Aggregate Demand Curve
Real Domestic Output, GDP
Price Level
AD
Aggregate
Demand
Changes in Aggregate Demand – two parts
Real Domestic Output, GDP
Price Level
AD1
Increase in
Aggregate
Demand
AD3
AD2
Decrease in Aggregate
Demand
Determinants of Aggregate Demand (curve shifters)
Change in Consumer Spending
Consumer Wealth
Consumer Expectations
Household Indebtedness
Taxes
Change in Investment Spending
Real Interest Rates – (due to change in money supply)
Expected Rates of Return change due to:
Expected Future Business Conditions
Technology
Degree of Excess Capacity
Business Taxes
Determinants of Aggregate Demand (curve shifters)
Government Spending
Net Export Spending
National Income Abroad
Exchange Rates:
depreciation of the $
Dollar depreciates relative to euro – US goods cheaper, while euro goods more expensive – AD curve shifts to right.
appreciation of the $
Dollar appreciates relative to euro – US goods more expensive, while euro goods cheaper – AD curve shifts to left
Aggregate Supply
A Schedule or curve showing the relationship between the price level and the amount of domestic output the firms in the economy produce.
Three time horizons
Immediate short run
Assumptions:
Input prices and output prices are fixed
Time period - Few days to a few months
Possible implicit price agreements
Contractual agreements
Impact on output (AS)?
Aggregate Supply – immediate short run
Real Domestic Output, GDP
Price Level
ASISR
Immediate-short-run Aggregate Supply.
Firms supply the level of output that is demanded at that price. Perfectly elastic supply curve.
Qf
Short run
Assumptions:
Input prices fixed
Output prices variable
Real profit changes (output adjustments)
Impact on output (AS)?
Aggregate Supply
Real Domestic Output, GDP
Price Level
0
Qf
Aggregate Supply
(Short Run)
As output increases,
Per unit production costs
Increase, output increases
Become more limited.
Slope not constant: per unit production cost and firm capacity
Aggregate Supply – short run
Long run
Assumptions:
All prices variable
Full employment GDP achieved (no output adjustment)
All prices adjust
Impact on output (AS)?
Aggregate Supply
Aggregate Supply – long run
Real Domestic Output, GDP
Price Level
ASLR
Long-run
Aggregate
Supply.
Wages and other input prices rise and fall to match output price level changes.
Price level changes do not alter output
Qf
Input prices fully Adjust to
output price level Changes.
Real Domestic Output, GDP
Price Level
AS1
Increase in
Aggregate
Supply
AS3
AS2
Decrease in
Aggregate
Supply
Aggregate Supply
Determinants of Aggregate Supply
Input Prices
Domestic Resource Prices
Labor – supply increases or decreases
Land – discoveries or depletion of resources
Capital – input prices change
Prices of Imported Goods
Market Power – like OPEC
Determinants of Aggregate Supply
Productivity
Productivity
=
Total Output
Total Inputs
Legal-Institutional Environment
Business Taxes and Subsidies
Government Regulation
Changes in Equilibrium
Real Domestic Output, GDP
Price Level
AD
AS
P1
P2
Q1
Qf
AD1
Increase in Aggregate Demand
Demand-Pull
Inflation
Changes in Equilibrium
Real Domestic Output, GDP
Price Level
AD1
AS
P1
P2
Q2
Qf
AD2
Decrease in Aggregate Demand
Creates a
Recession
a
c
b
21
21
Decrease in Aggregate Demand
Recession and cyclical unemployment
Deflation?
Reasons for Downward price inflexibility:
Fear of price wars
Menu costs
Wage contracts
Morale, effort, and productivity
Efficiency wages
Minimum Wage
Changes in Equilibrium
Real Domestic Output, GDP
Price Level
AD
AS1
P1
P2
Q1
Qf
Decrease in Aggregate Supply
Cost-Push
Inflation
AS2
a
b
Changes in Equilibrium
Real Domestic Output, GDP
Price Level
AD1
AS2
P1
P2
Q2
Q1
Increases in Aggregate Supply – Full-Employment With Relative Price-Level Stability
AS1
b
AD2
c
P3
Q3
a
Changes in Equilibrium
