Presentation on theme: "Ch.10- Aggregate Demand/Aggregate Supply"— Presentation transcript:
1 Ch.10- Aggregate Demand/Aggregate Supply BY J.A.SACCO
2 C+I+G+(X-M) Let Us Build Our Model! Go Back to GDP Chapter deals with why business activity fluctuates. A way to explain changes in output/unemployment/price level.Go Back to GDPC+I+G+(X-M)
3 C+I+G+(X-M) Let Us Build Our Model! The components of GDP determine the value of totalexpenditures. Consumers, Business Capital Investment,Government, Foreign Markets make these spending decisions.
4 Answered by developing? Let Us Build Our Model!However, this much to simple an explanation. Two issues much be answered.What determines the total amount that individuals, firms, governments, and foreigners want to spend?What determines whether this spending will result in a higher output of goods/services (quantity) or higher prices (inflation)?Aggregate Demand and Aggregate SupplyAnswered by developing?
5 Let Us Build Our Model!Aggregate Demand- TOTAL of all planned expenditures for the entire economy.Aggregate Supply- TOTAL of all planned production for the entire nation.
6 Aggregate Demand Aggregate Demand Curve A curve showing planned purchase rates for all goods and services in the economy at various price levels, all other things held constantAD Curve is a shorthand way of illustrating the components of GDP.
7 Aggregate Demand C+I+G+(X-M) Furthermore, AD Curve gives the total amount of Real Domestic Income (RDI) that will be purchased at each price level.RDI = RGDPRemember Circular Flow.
8 The Aggregate Demand Curve ADCAs the price levelrises, real GDPdemanded declines140BPrice Level/ GDP Deflator120A10012345678910Real GDP per Year($ trillions)
9 The Aggregate Demand Curve ADAAs the price levelfalls, real GDPdemanded increases140BPrice Level/GDP Deflator120C10012345678910Real GDP per Year($ trillions)
10 Houston, We May Have a Problem! Question- Why might the Law of Demand and the reasons for the downward slope of the demand curve not be applicable with aggregate demand.Law of Demand (one good/service) statesPrQDPrQD
11 Houston, We May Have a Problem! Now dealing with the entire macroeconomy. Price level is the average price of all goods and services including wages. Remember, when the price level for goods/service increased the consumer would substitute other goods/services. Now there are no substititues.The Law of Demand still applies and the aggregate demand curve is still downward sloping but for different reasons.
12 Downward Slope of the Aggregate Demand Curve? What Happens When the Price Level Changes?The Direct Effect: The Real-Balance Effect (wealth effect)The Indirect Effect: The Interest Rate EffectThe Open Economy Effect: The Substitution of Foreign Goods
13 The Aggregate Demand Curve The Real-Balance EffectThe change in the real value (purchasing power) of money balances when the price level changes.While your nominal cash value stays the same, any change in the price level will cause a change in the real value (purchasing power) of cash balances.
14 The Aggregate Demand Curve The Interest Rate Effect- Change in the price level indirectly effects the interest rate.When price level increases, you go out to replace your lost purchasing power.This greater demand for money causes the nominal interest rate to increase.As interest rates rise this makes borrowing less attractive thus reducing the quantity of AD.Lets look at a Price Level increase.A decrease in the price level works in the opposite direction.
15 The Aggregate Demand Curve The Open Economy EffectHigher price levels result in foreigners’ desiring to buy fewer American-made goods while Americans desire more foreign-made goods (i.e. net exports fall)This decline in net exports causes a decrease in the quantity of aggregate demand.
16 Review- A Change in the Price Level Direct Effect/Real Balance Effect/Wealth EffectIf PLPurchasing PowerRate of ConsumptionQuantity ADIf PLPurchasing PowerRate of ConsumptionQuantity AD
17 Review- A Change in the Price Level Indirect Effect/ Interest Rate EffectIf PL Demand for MoneyNominal Interest RateConsumption/ InvestmentQuantity ADDemand for MoneyIf PL
18 Review- A Change in the Price Level Open-Economy EffectIf PL U.S. goods/services more expensive than foreign. Substitute foreign goods for U.S. goods/services.Quantity ADIf PL U.S. goods/services cheaper than foreign. More U.S. goods/services purchased than foreign. Quantity AD
19 Review- A Change in the Price Level Remember with any of these three reasons, it is a change in the Price Level. You are only moving up/down the AD curve.
20 Non- Price Determinants of Aggregate Demand Any non-price-level change that effects any component of:C + I + G + (X-M)will cause a shift in the AD curve.
21 Non- Price Determinants of Aggregate Demand Any non-price-level change that increases aggregate spending (on domestic goods) shifts AD to the right.A drop in the foreign exchange value of the dollarIncreased security about jobs and future incomeImprovements in economic conditions in other countriesA reduction in real interest rates (nominal interest rates corrected for inflation) not due to price level changesTax decreases (Fiscal Policy)An increase in the amount of money in circulation (Monetary Policy)
22 Shifts in the Aggregate Demand Curve Increase inAggregateDemandAD120GDP Deflator90AD11234567Real GDP per Year($ trillions)
23 Determinants of Aggregate Demand Any non-price-level change that decreases aggregate spending (on domestic goods) shifts AD to the left.A rise in the foreign exchange value of the dollarDecreased security about jobs and future incomeDeclines in economic conditions in other countriesA rise in real interest rates (nominal interest rates corrected for inflation) not due to price level changesTax increases (Fiscal Policy)An decrease in the amount of money in circulation (Monetary Policy)
24 Shifts in the Aggregate Demand Curve Decrease inAggregateDemandAD120GDP Deflator90AD11234567Real GDP per Year($ trillions)