Final exam of macroeconomics
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chiang4e_ch09ASADIntroduction.pptxCHAPTER 20 SLIDE 1
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Aggregate Demand
and Supply
SLIDES CREATED BY ERIC CHIANG
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1
Explain what an aggregate demand curve is and what it represents.
Describe why the aggregate demand curve has a negative slope due to the wealth, export, and interest rate effects.
List the determinants of aggregate demand.
Analyze the aggregate supply curve and differentiate between the short run and long run.
CHAPTER OBJECTIVES
CHAPTER 20
SLIDE 2
2
CHAPTER OBJECTIVES
Describe the determinants of an aggregate supply curve.
Use AD/AS analysis to illustrate long-run and short-run macroeconomic equilibrium.
SLIDE 3
CHAPTER 20
3
EXPLAINING BUSINESS CYCLES
SLIDE 4
Two ways to think about business cycles:
The Short-Run or Keynesian Model
The Long-Run or Neoclassical Model
CHAPTER 20
4
A TYPICAL BUSINESS CYCLE
SLIDE 5
Trend
Peak
Peak
Trough
Recession
Recovery
REAL GDP
TIME
CONTRACTION
EXPANSION
CHAPTER 16
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EXPLAINING BUSINESS CYCLES
SLIDE 6
Three Important Tools:
The Production Possibilities Model
The Circular Flow Model
The Aggregate Demand and Aggregate Supply Model
CHAPTER 20
6
EXPLAINING BUSINESS CYCLES
SLIDE 7
The Production Possibilities Model:
The short-run or Keynesian perspective assumes the PPF is fixed and the business cycle occurs as we move from the PPF to inside the PPF and back.
Expansions and Contractions given existing productive capacity
CHAPTER 20
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EXPLAINING BUSINESS CYCLES
SLIDE 8
The Production Possibilities Model:
The long-run or Neoclassical perspective seeks to shift the PPF outward over time.
Generate economic growth by expanding the productive capacity
CHAPTER 20
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EXPLAINING BUSINESS CYCLES
PPFA
Short-run expansion is shown as a movement toward a PPF, while long-run growth is shown as an expansion of the PPF.
SHORT-RUN GROWTH
SLIDE 9
a
b
PPFB
LONG-RUN GROWTH
PPFA
CHAPTER 18
9
EXPLAINING BUSINESS CYCLES
SLIDE 10
The Circular Flow Model:
How is current output and income being distributed among the decision makers in the economy.
Short-run expansions and contractions can be explained by changes in expenditures in the product market.
CHAPTER 20
10
Expanded Model
Resource Market
Product Market
Consumption
Gross Domestic Product
Wages, Rent, Interest, and Profit
Gross Domestic Income
Saving
Investment
Government
Sector
Government Purchases
Transfer Payments
Taxes
CIRCULAR FLOW DIAGRAM
Foreign Sector
Imports
Exports
Govt.
Deficit/Surplus
Financial Market
Business
Households
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EXPLAINING BUSINESS CYCLES
SLIDE 12
The Aggregate Demand and Aggregate Supply Model:
Output, employment, and prices are determined by the interaction of total spending and production in the economy.
Both long-run and short-run changes can be explained
CHAPTER 20
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EXPLAINING BUSINESS CYCLES
SLIDE 13
0
SRAS
AGGREGATE PRICE LEVEL (P)
AGGREGATE OUTPUT (Q)
Short-run macroeconomic equilibrium occurs where ad and sras intersect.
Pe
AD
e
Qf
LRAS
long-run macroeconomic equilibrium occurs where ad and lras intersect.
CHAPTER 20
THE AGGREGATE DEMAND CURVE SHOWS THE OUTPUT OF GOODS AND SERVICES (REAL GDP) DEMANDED AT DIFFERENT PRICE LEVELS.
SLIDE 14
SEAN PAVONE/ALAMY
CHAPTER 20
AGGREGATE DEMAND
SLIDE 15
P1
0
Q1
AD0
AGGREGATE PRICE LEVEL (P)
AGGREGATE OUTPUT (Q)
b
a
Q0
P0
A higher aggregate price causes lower aggregate output.
Aggregate demand slopes down because of the wealth effect, export price effect, and interest rate effect.
CHAPTER 20
AGGREGATE DEMAND
SLIDE 16
Export price effect: As prices rise, exports become more expensive, and exports drop.
Interest rate effect: As prices rise, people hold more money, pushing interest rates higher, reducing business investment.
Wealth effect: As prices rise, purchasing power of wealth falls, reducing consumption.
CHAPTER 20
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DETERMINANTS OF AGGREGATE DEMAND
SLIDE 17
The determinants of aggregate demand are factors that shift the entire AD curve when they change:
Consumption
Investment
Government spending
Net exports
Money Supply
CHAPTER 20
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DETERMINANTS OF AGGREGATE DEMAND
SLIDE 18
Notice that the factors that shift the AD curve are things that change total expenditures in the Circular Flow model.
CHAPTER 20
18
SHIFTS IN AGGREGATE DEMAND
SLIDE 19
P1
0
Q1
AD0
AGGREGATE PRICE LEVEL (P)
AGGREGATE OUTPUT (Q)
b
a
Q0
P0
A factor that shifts aggregate demand to the right will increase output at every price level.
AD1
Q2
CHAPTER 20
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DETERMINANTS OF AGGREGATE DEMAND
SLIDE 20
Why AD changes depends on your perspective:
The Keynesian short-run perspective says AD changes because of changes in spending; C, I, G, and NX.
The Neoclassical long-run perspective says AD changes because of changes in the money supply.
CHAPTER 20
20
THE AGGREGATE SUPPLY CURVE SHOWS THE REAL GDP THAT FIRMS WILL PRODUCE AT VARYING PRICE LEVELS.
SLIDE 21
ZUMA PRESS, INC/ALAMY
CHAPTER 20
LONG-RUN AGGREGATE SUPPLY
In the long run, the aggregate supply curve is vertical.
This incorporates the approach of neoclassical economic analysis, which assume that all wages and prices are adjustable in the long run.
SLIDE 22
In the long run, the economy will gravitate toward full employment.
CHAPTER 20
22
SHIFTING THE LRAS CURVE
The position of the LRAS curve depends on the economy’s capacity:
Amount of available resources
The quality of the labor force
Available technology
SLIDE 23
Full employment depends on the PPF which determines the position of the LRAS curve.
CHAPTER 20
23
SHIFTING THE LRAS CURVE
Rightward shifts in LRAS can occur when:
technology improves: automation, digitalization.
labor quality is enhanced; more people pursue higher education.
trade and globalization increase.
SLIDE 24
Increasing the LRAS means an outward shift of the PPF which takes time.
CHAPTER 20
24
SLIDE 25
AGGREGATE PRICE LEVEL (P)
AGGREGATE OUTPUT (Q)
LRAS0
A shift in the long-run aggregate supply curve moves the economy to a new long-run level of output.
0
Q0
LRAS1
Q1
CHAPTER 20
SHIFTING THE LRAS CURVE
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SHORT-RUN AGGREGATE SUPPLY
In the short run, the aggregate supply curve is upward sloping.
Keynesians assume input prices (such as wages) are slow to change; they are sticky.
When product prices rise but input prices are sticky, profits increase and firms produce more, resulting in a short-run increase in aggregate output.
SLIDE 26
CHAPTER 20
26
SHORT-RUN AGGREGATE SUPPLY
SLIDE 27
0
SRAS
AGGREGATE PRICE LEVEL (P)
AGGREGATE OUTPUT (Q)
SRAS is positively sloped because input costs are slow to change. (they are sticky.)
CHAPTER 20
DETERMINANTS OF SRAS
SLIDE 28
The determinants of the short-run aggregate supply curve are:
quantity
quality of resources
technology and productivity.
changes in input prices.
taxes and regulation.
market power of firms.
inflationary expectations.
CHAPTER 20
28
SHIFTS OF THE SRAS CURVE
SLIDE 29
P0
0
Q0
SRAS0
AGGREGATE PRICE LEVEL (P)
AGGREGATE OUTPUT (Q)
a
b
Q1
A factor that shifts SRAS to the right will increase aggregate output at every price level.
SRAS1
CHAPTER 20
29
SHIFT OF THE SRAS CURVE
Notice that:
When the LRAS shifts, the SRAS must also shift
The SRAS can shift without changing the LRAS
SLIDE 30
CHAPTER 20
30
SLIDE 31
AGGREGATE PRICE LEVEL (P)
AGGREGATE OUTPUT (Q)
LRAS0
0
Q0
LRAS1
Q1
CHAPTER 20
SHIFTING THE LRAS CURVE
SRAS0
SRAS1
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SLIDE 32
AGGREGATE PRICE LEVEL (P)
AGGREGATE OUTPUT (Q)
LRAS0
0
Q0
CHAPTER 20
SHIFTING THE LRAS CURVE
SRAS0
SRAS1
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WHICH OF THE FOLLOWING DOES NOT OCCUR WHEN AGGREGATE PRICE FALLS?
B
C
A
AGGREGATE DEMAND INCREASES.
EMPLOYMENT FALLS.
AGGREGATE SUPPLY INCREASES.
D
E
THE MONEY SUPPLY FALLS.
AGGREGATE OUTPUT INCREASES.
SLIDE 33
CHAPTER 20
Answer: E
33
WHICH OF THE FOLLOWING DOES NOT OCCUR WHEN AGGREGATE PRICE FALLS? (Answer)
B
C
A
AGGREGATE DEMAND INCREASES.
EMPLOYMENT FALLS.
AGGREGATE SUPPLY INCREASES.
D
E
THE MONEY SUPPLY FALLS.
AGGREGATE OUTPUT INCREASES. (Correct Answer)
SLIDE 34
CHAPTER 20
Answer: E
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CHAPTER 2
SLIDE 35
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PRACTICE QUESTION
HOW WOULD DISCOVERING A NEW OIL FIELD AFFECT THE LONG-RUN AGGREGATE SUPPLY?
The new oil field increases the amount of resources available and increase the long-run aggregate supply. (Shift the LRAS curve to the right.)
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WHICH OF THE FOLLOWING WOULD SHIFT THE SHORT-RUN AGGREGATE SUPPLY CURVE TO THE RIGHT?
B
C
A
A SPIKE IN INPUT PRICES
AN INCREASE IN TAXES
HIGHER INTEREST RATES
D
A RISE IN PRODUCTIVITY
SLIDE 36
E
INCREASED REGULATION
CHAPTER 20
Answer: D
36
WHICH OF THE FOLLOWING WOULD SHIFT THE SHORT-RUN AGGREGATE SUPPLY CURVE TO THE RIGHT? (Answer)
B
C
A
A SPIKE IN INPUT PRICES
AN INCREASE IN TAXES
HIGHER INTEREST RATES
D
A RISE IN PRODUCTIVITY (Correct Answer)
SLIDE 37
E
INCREASED REGULATION
CHAPTER 20
Answer: D
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MACROECONOMIC EQUILIBRIUM
Combining the AD and AS curves allows us to think about the short run and long run effects of changes in the economy:
Output, employment, and the price level are determined by the intersection of the AD and AS curves; macroeconomic equilibrium.
SLIDE 38
CHAPTER 20
38
MACROECONOMIC EQUILIBRIUM
SLIDE 39
0
SRAS
AGGREGATE PRICE LEVEL (P)
AGGREGATE OUTPUT (Q)
Short-run macroeconomic equilibrium occurs where ad and sras intersect.
Pe
AD
e
Qf
LRAS
long-run macroeconomic equilibrium occurs where ad and lras intersect.
CHAPTER 20
MACROECONOMIC EQUILIBRIUM
It is possible to have a short-run equilibrium without a long-run equilibrium:
Changes in the AD or the SRAS can result in production and employment that are above or below full employment.
Changes in the short-run business cycle
SLIDE 40
CHAPTER 20
40
AN INCREASE IN AD
SLIDE 41
0
SRAS0
AGGREGATE PRICE LEVEL (P)
AGGREGATE OUTPUT (Q)
Rising input prices eventually push SRAS to the left, back to long-run equilibrium but at a higher price level.
P1
AD0
a
Qf
LRAS
An increase in AD expands the economy beyond full employment output in the short run.
P0
e
Q1
AD1
SRAS1
P2
CHAPTER 20
b
41
A DECREASE IN THE SRAS
SLIDE 42
0
SRAS0
AGGREGATE PRICE LEVEL (P)
AGGREGATE OUTPUT (Q)
Neoclassical economists argue that the recession will reduce wages and prices, decreasing the SRAS and reducing both inflation and unemployment.
P1
AD0
Qf
LRAS
A decrease in the SRAS reduces output and raises prices.
P0
e
Q1
SRAS1
CHAPTER 20
a
42
A DECREASE IN THE SRAS
SLIDE 43
0
SRAS0
AGGREGATE PRICE LEVEL (P)
AGGREGATE OUTPUT (Q)
Keynesian economists say there are two choices. Increasing AD will push output back to full employment but at even higher prices. Alternatively, decreasing AD will reduce inflation but increase unemployment even more.
P1
AD0
b
Qf
LRAS
P0
e
Q1
AD1
SRAS1
P2
CHAPTER 20
c
a
AD2
Q2
43
AN INCREASE IN THE LRAS
Changes in the LRAS change output, employment and prices in the long run:
The full employment level of output increases as the LRAS increases.
An increase in the LRAS will also increase the SRAS.
SLIDE 44
CHAPTER 20
44
AN INCREASE IN THE LRAS
SLIDE 45
0
SRAS0
AGGREGATE PRICE LEVEL (P)
AGGREGATE OUTPUT (Q)
Neoclassical economists argue that an increase in AD can prevent the price level from falling.
P1
AD0
Q0
LRAS0
An increase in the LRAS raises output and reduces prices; Q1 is the new full employment output.
P0
e
Q1
SRAS1
CHAPTER 20
LRAS1
a
45
ABUNDANT SNOWFALL AND RISING INCOMES HAVE LED TO RECORD SKI INDUSTRY INCOME. HOW DOES THIS AFFECT THE MACROECONOMY?
SLIDE 46
PRACTICE QUESTION
ERIC CHIANG
CHAPTER 20
Answer: If increased demand in the ski industry is indicative of the overall economy (more spending for all goods and services), then AD shifts to the right. However, if skiing substitutes for other trips (like beach vacations), then the impact is less certain. An increase in AD will increase aggregate output, either toward full employment (if the economy was previously below full employment), or above full employment, which may lead to demand-pull inflation.
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IF AN ECONOMY IS OPERATING ABOVE FULL EMPLOYMENT, WHAT IS LIKELY TO HAPPEN IN THE LONG RUN?
B
C
A
INPUT PRICES AND WAGES RISE; SRAS SHIFTS TO THE LEFT.
INPUT PRICES AND WAGES RISE; SRAS SHIFTS TO THE RIGHT.
INPUT PRICES AND WAGES FALL; SRAS SHIFTS TO THE LEFT.
D
INPUT PRICES AND WAGES FALL; SRAS SHIFTS TO THE RIGHT.
SLIDE 47
CHAPTER 20
Answer: A
47
IF AN ECONOMY IS OPERATING ABOVE FULL EMPLOYMENT, WHAT IS LIKELY TO HAPPEN IN THE LONG RUN? (Answer)
B
C
A
INPUT PRICES AND WAGES RISE; SRAS SHIFTS TO THE LEFT. (Correct Answer)
INPUT PRICES AND WAGES RISE; SRAS SHIFTS TO THE RIGHT.
INPUT PRICES AND WAGES FALL; SRAS SHIFTS TO THE LEFT.
D
INPUT PRICES AND WAGES FALL; SRAS SHIFTS TO THE RIGHT.
SLIDE 48
CHAPTER 20
Answer: A
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END OF CHAPTER
SLIDES CREATED BY ERIC CHIANG
CHAPTER 20
SLIDE 47
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