3 What is Aggregate Demand? Aggregate Demand is all the goods and services that buyers are willing and able to purchase at different price levels.Aggregate means “added all together.”The Demand for everything by everyone in the US.
4 Aggregate Demand Curve AD is the demand by consumers, businesses, government, and foreign countriesPriceLevelThere is an inverse relationship betweenprice level and Real GDP.ADReal domestic output (GDPR)
6 Shifts in Aggregate Demand ** General rule: An increase in spending shifts AD right, and decrease in spending shifts it leftPriceLevelAD1ADAD2Real domestic output (GDPR)6
7 Shifters of Aggregate Demand Change in Consumer SpendingConsumer Wealth (Boom in the stock market…)Consumer Expectations (People fear a recession…)Household Indebtedness (More consumer debt…)Income Taxes (Decrease in income taxes…)Wealth= assets that generate money (real estate, stock, property)* Important note: A change in WAGES does NOT impact C in AD because a change in nominal wages does mean a change in REAL wages (purchasing power)
8 Shifters of Aggregate Demand 2. Change in Investment Spendingbusiness puts $ back into the businessInterest Rates (Price of borrowing $)Future Business Expectations (High expectations…)Business Taxes (Higher corporate taxes means…)Capital stock, construction and inventory
9 Shifters of Aggregate Demand Change in Government Spending(infrastructure…)(Nationalized Heath Care…)(defense spending…)Change in Net Exports(foreign income)If dollar depreciates, more Europeans will buy US products causing Net Exports to increaseAD = GDP = C + I + G + Xn9
10 Topic 2: The Multiplier Effect Why do cities want the Superbowl in their stadium?10
11 MULTIPLIER EFFECTSomeone’s spending (whether it be consumer, business, government etc) will always become someone else’s incomeThe person who receives the income will turn around and spend it and the cycle continuesBecause of this there is a multiplied impact of spending on the economy.
12 Marginal Propensity to Consume Marginal Propensity to Consume (MPC)How much people consume rather than save when there is a change in income.MPC=Change in ConsumptionChange in IncomeExamples:If you received $100 and spent $50.If you received $100 and spent $80.If you received $100 and spent $90.12
13 Marginal Propensity to Save Marginal Propensity to Save (MPS)How much people save rather than consume when there is a change in income.MPS=Change in SavingChange in IncomeExamples:If you received $100 and save $50. MPS?If you received $100 and save $30. MPS?13
14 Because people can either save or consume MPC + MPS = 1Why is this true?Because people can either save or consume14
15 How is Spending “Multiplied”? Assume the MPC is .5 for everyoneAssume the Super Bowl comes to town and there is an increase of $100 in Ashley’s restaurant.Ashley now has $100 more income.She saves $50 and spends $50 at Carl’s SalonCarl now has $50 more incomeHe saves $25 and spends $25 at Dan’s fruit standDan now has $25 more income.This continues until every penny is spent or saved15
16 How multiplier effect works New income of $100 ; MPC = .5* remember someone’s spending becomes someone else’s incomeRoundIncomeSpendingSavings1$100$502$253$12.50
17 Spending multiplierIf an increase in spending = more $ goes into the economy (total GDP will increase)1/MPSIf a decrease in spending = less $ goes into the economy(total GDP will decrease)- 1/MPS
18 Practice1. If MPC is .8, what is the spending multiplier if investment spending decreases???2. If the MPS is .1, what is the spending multiplier if government spending increases???The smaller the MPS, the greater the spending multiplier will be!!!
19 How to use the spending multiplier If Consumer Spending increases by $3 million, and the MPC is .8 How much will the GDP change by?spending multiplier X change in spendingHow figured:1. find spending multiplier1/MPS = 1/.2 = 52. Multiply the spending multiplier by the change in spending:3 X 5 = $15GDP will increase by a total of $15 million (5 X 15)
20 Tax Multiplier looks at the impact of taxes on the entire economy If taxes go down:If taxes go down, people have more $ to spend MPC/MPS (if decrease in taxes)If taxes go up:If taxes go up, people have less money to spend- MPC/MPS (if increase in taxes)
21 Practice MPC is .9, and taxes go up, what is the TAX multiplier??? MPS is .2, and taxes go down, what is the TAX MULTIPLIER???
22 How to use the tax mutiplier If the government decreases taxes by $50 million, and the MPC is .8 by how much will the GDP change by?Tax multiplier X change in TAXESHow figured:1. Find Tax multiplier.8/.2 = 42. Multiple tax multiplier by change in taxes4X50 = $200GDP will increase by $200 million
23 Balanced Budge Multiplier Spending multiplier will always have a bigger impact on the economy than tax multiplier if spending and taxes both change by the same amount!
24 Balanced Budget Multiplier The G attempts to balance the budget by changing taxes and spending at the same timeThe spending multiplier and the tax multiplier combine to from the BALANCED BUDGET MULTIPLIERBALANCED BUDGET MULTIPLIER = 11 X change = impact on the economy
25 How to use the balanced budget multiplier In order to balance the budget, the G increases spending by $20 million while at the same time raising taxes by $20 million.$20 X 1 = $20GDP will INCREASE by: $20 million
27 What is Aggregate Supply? The supply for everything by all firms. Aggregate Supply is the amount of goods and services that firms will produce in an economy at different price levels.The supply for everything by all firms.Aggregate Supply differentiates between short run and long-run and has two different curves.27
28 Short Run Aggregate Supply Curve PriceLevelASAS is the production of all the firms in the economyReal domestic output (GDPR)28
30 Shifts in SR Aggregate Supply An increase or decrease in national production can shift the curve right or leftAS2PriceLevelASAS1Real domestic output (GDPR)30
31 Shifters of SR Aggregate Supply 1. Change in ResourcesPrices and quantity of Domestic and ImportedResourcesNominal wagesSupply Shocks(Negative Supply shock…)(Positive Supply shock…)
32 Shifters of SR Aggregate Supply Legalities* Business taxes (shifts AD too!)SubsidesGovernment RegulationsChange in ProductivityChange in Technology32
33 Topic 4: Classical vs. Keynesian view of SRAS Adam SmithJohn Maynard Keynes33
34 CLASSICAL THEORY 1. AS is VERTICAL (at FE) 2. WAGES are FLEXIBLE (both upward and downward) AND ADJUST QUICKLY TO PRICE CHANGES3. Economy can self adjust4. No G intervention in economy is necessary
35 Debates Over Aggregate Supply Classical Theory – AS is verticalASPrice levelQfReal domestic output, GDP35
36 Debates Over Aggregate Supply Classical TheoryDue to wages being flexible, a change in AD will not change quantity, only price levelASPrice levelADQfReal domestic output, GDP36
37 1. AS is horizontal at low output Keynesian Theory1. AS is horizontal at low output2. Wages are STICKY – they do NOT quickly adjust to price changes3. G intervention is necessary to return economy to FE37
38 Keynesian Theory- Horizontal AS Recession will be persistent because wages are not flexible (they will not go down to return the economy to FE)Price levelASQQReal domestic output, GDP38
39 Debates Over Aggregate Supply Keynesian TheoryA change in AD effects output only not inflationPrice levelASAD2AD1Q1QfReal domestic output, GDP39
40 Three Ranges of Aggregate Supply 1. Keynesian Range- Horizontal at low output2. Intermediate Range- Upward sloping3. Classical Range- Vertical at FEASPrice levelClassicalRangeKeynesianRangeIntermediateRangeReal domestic output, GDP40
41 Topic 5: LONG RUN Aggregate Supply In the Short Run, wages haven’t had the time to adjust to price changesExample:If a firm currently makes 100 units that are sold for $1 each. The only cost is $80 of labor.How much is profit?Profit = $100 - $80 = $20What happens in the SHORT-RUN if price level doubles?Now 100 units sell for $2, TR=$200.How much is profit? Wages haven’t had the time to adapt to the change in pricesProfit = $120With higher profits, the firm has the incentive to increase production.41
42 Long-Run Aggregate Supply In the Long Run, wages do have time to adjust to price changesSame Example:The firm has TR of $100 and uses $80 of labor.Profit = $20.What happens in the LONG-RUN if price level doubles?TR still =$200 (100 x $2)BUT…In the LONG RUN workers demand higher wages to match prices. Wages have had the time to adjust to price changes - So labor costs double to $160Profit = $40, but REAL profit is unchanged.If REAL profit doesn’t changethe firm has no incentive to increase output.42
43 Long run Aggregate Supply In Long Run: Q at FE on LRAS; price level can be any levelLRASPrice levelLong-runAggregateSupplyFull-Employment(Trend Line)QYGDPR43
45 Shifters of LRAS LRAS similar to PPC!!! Change in technology Change in QUANTITY of resources* General rule: LRAS will never shift by itself (SRAS will shift with it) However, SRAS can shift without LRAS shifting
47 Which curve will shift??? AD, SRAS, LRAS 1. An increase in consumer confidence2. An increase in incomes of U.S. trading partners3. A large decrease in the price of imported oil which impacts the resource cost of business4. An increase in business taxes5. An improvement in technology6. 25% stock market increase over a two month period which increases household wealth7. a decrease in interest rates8. A increase in wages
48 Topic 6: Putting AD and AS together to get Equilibrium Price Level and Output 48
49 Topic 7: Economic Stability A stable economy is represented by:Economic growthPrice stabilityFull employment
60 Shifts in AD or AS change the price level and output in the SR, but only price level in the LR LRASPrice LevelASPLeADQYGDPR60
61 Example: Assume inflation is occurring in the economy Price LevelLRASASPL1AD1ADQYQ1GDPR61
62 Now, what will happen in the LONG RUN? Inflation means workers seek higher wages and wages increase (shifts AS to LEFT)LRASPrice LevelAS1ASPL2Back to full employment with higher price levelPL1ADQYQ1GDPR62
63 LRAS Price Level AS PL1 AD AD AD1 Q1 QY Example: Assume a recession is occurring in the economyPrice LevelLRASASPL1ADADAD1Q1QYGDPR63
64 AS increases as workers accept lower wages and production costs fall What happens in the Long Run? Due to recession, workers accept lower wages. As WAGES go down, SRAS shifts to the rightPrice LevelLRASASAS1AS increases as workers accept lower wages and production costs fallShort Run -AD Falls, PL and Q fallLong Run- AS Increases as workers accept lower wages and production costs fall. PL goes down, Q goes back to Full EmploymentPL1PL2ADQ1QYGDPR64
65 A ratchet (socket wrench) tool forward but not backward. The Ratchet EffectA ratchet (socket wrench)permits one to crank atool forward but not backward.65
66 Does deflation (falling prices) often occur? Not as often as inflation. Why?Prices and wages are more flexible upward as opposed to downwardLike a ratchet, prices can easily move up but not down!66
67 Topic 9: The Phillips Curve SRPC Shows tradeoff between inflation and unemployment.
68 Short Run Phillips Curve When the economy is overheating, there is low unemployment but high inflation (A)InflationWhen there is a recession, unemployment is high but inflation is low (B)5%AShort Run -AD Falls, PL and Q fallLong Run- AS Increases as workers accept lower wages and production costs fall. PL goes down, Q goes back to Full Employment1%BSRPC2%9%Unemployment68
69 Shifts of Short run Phillip’s curve inflation and unemployment move in the SAME direction, there will be a SHIFT of the SRPC-If inflation and unemployment both go up; SRPC shifts to the RIGHT- If both go down, SRPC shifts to the LEFTChange in inflationary expectationsif these increase, SRPC shifts RIGHTif these decrease, SRPC shifts LEFT
70 Assume stagflation occurs Draw an AD/AS graph showing this SRAS SHIFTS TO THE LEFTIn the Short run, what happensPrice level? increasesUnemployment? increasesShort Run -AD Falls, PL and Q fallLong Run- AS Increases as workers accept lower wages and production costs fall. PL goes down, Q goes back to Full Employment70
71 What is impact on SRPC? Shifts to the right InflationShort Run -AD Falls, PL and Q fallLong Run- AS Increases as workers accept lower wages and production costs fall. PL goes down, Q goes back to Full EmploymentSRPC1SRPCUnemployment71
72 Consumers begin to save more money. Draw an AD/AS graph that shows this AD SHIFTS TO THE LEFT In the short run, what happens to Price level? Decreases Unemployment? INcreases
73 Movement down along original curve What is impact on SRPC?Movement down along original curveInflationABShort Run -AD Falls, PL and Q fallLong Run- AS Increases as workers accept lower wages and production costs fall. PL goes down, Q goes back to Full EmploymentSRPCUnemployment73
74 The prices of resources decrease.Draw an AD/AS graph showing this SRAS SHFITS TO THE RIGHT What happens in the short run to price level? decreases unemployment? decreases
75 What is impact on SRPC? Shifts to the left InflationShort Run -AD Falls, PL and Q fallLong Run- AS Increases as workers accept lower wages and production costs fall. PL goes down, Q goes back to Full EmploymentSRPCSRPC 1Unemployment75
76 From Short run Phillips curve to Long run Phillips curve Because the SRPC is continually shifting in the LONG RUN, there is no trade off between inflation and unemployment
77 Example: The economy is at FE and interest rates increase What problem does this create? RECESSIONWhat happens in the long run to…Price level DECREASESUnemployment DECREASESWhat will happen to the SRPC in the Long Run?SHIFTS to the LEFT
78 Example: The economy is at FE and consumer spending increases What problem does this create? INFLATIONWhat happens in the long run to…Price level? INCREASESUnemployment INCREASESWhat will happen to the SRPC in the Long Run?SHIFTS TO the RIGHT
79 The LRPC is vertical at the Natural Rate of Unemployment In the long run there is no tradeoff between inflation and unemployment due to SRPC continually shiftingLRPCInflation5%The LRPC is vertical at the Natural Rate of Unemployment3%Short Run -AD Falls, PL and Q fallLong Run- AS Increases as workers accept lower wages and production costs fall. PL goes down, Q goes back to Full Employment1%2%5%9%Unemployment79
80 SHIFTS OF LRPCLRPC can shift if there is a change in the Natural rate of unemploymentLRPC will never shift by itself (if you shift LRPC, shift SRPC too!)
81 Phillips curve at FE equilibrium LRPCThe unemployment rate is at the NATURAL RATEandinflation rate is at the EXPECTED RATEInflationSRPCUYUnemployment81
82 Inflationary Gap on Phillips Curve LRPCInflationSRPCUYUnemployment82
83 Recessionary Gap on the Phillips Curve LRPCInflationSRPCUYUnemployment83
85 Fiscal Policy- Based on Keynesian theory Fiscal Policy: Actions by Congress to speed up or slow down the economyA stable economy should have:1. stable prices2. full employment3. economic growth
86 Two Types of Fiscal Policy 1. Discretionary Fiscal Policy-Congress creates and passes a new billex. Congress votes to implement a tax cut86
87 Two Types of Fiscal Policy 2. Automatic StabilizersPermanent spending or taxation laws enacted to work counter cyclically to stabilize the economyEx: Welfare, Unemployment, Min. Wage, etc.When there is high unemployment, unemployment benefits to citizens increase consumer spending.87
88 Expansionary Fiscal Policy Implemented during RECESSIONGoal is to SPEED UP economy without causing too much inflationNeed to increase AD
90 How can the government speed up the economy???? 1. Increase government spending (public works, roads, schools etc.) *need to account for the SPENDING MULTIPLIER 2. Decrease personal income taxes (Consumers will have more $, so they will spend more) *need to account for the TAX MULTIPLIER
91 * government can increase its spending, decrease taxes or do both – any of these actions increase AD Expansionary policy will result in a DEFICIT BUDGETDeficit Budget: the government spends more $ than what they take in
92 Contractionary Fiscal Policy Implemented during INFLATION Goal is to SLOW DOWN economy without causing recession Want to decrease AD
93 How can the government slow down the economy??? 1. Decrease government spending* need to account for spending multiplier2. Raise personal income taxes*need to consider tax multiplier
94 * Government can decrease its spending, raise income taxes or both – any of these actions will slow down the economy/decrease ADContractionary Policy results in a SURPLUS BUDGETSurplus Budget: the government spends less $ than what they take in
96 Problems With Fiscal Policy 1. Deficit Spending!!!!A Budget Deficit – government spending exceeds its revenue.The National Debt is the accumulation of all the budget deficits over time.Most economists agree that budget deficits are a necessary evil because forcing a balanced budget would not allow Congress to stimulate the economy.96
97 Additional Problems with Fiscal Policy 2 Problems of TimingRecognition Lag- Congress must react to economic indicators before it’s too lateAdministrative Lag- Congress takes time to pass legislation3. Politically Motivated PoliciesPoliticians may use economically inappropriate policies to get reelected.97
99 The National Debt: CNBC explains 1. What is the difference between deficit spending and the national debt?2. What is the DEBT CEILING?3. If the government borrows $, how does it get the money it needs?4. Who/what is the largest holder of U.S. debt?
100 Where does the State and local government get $ from???
101 Where does the Federal Government get its money???
102 Income taxes Tax based on the “income” a person earns Americans pay an income tax to:1. The federal government2. The state government3. The local governmentThese taxes appear on a person’s pay check stubThe purpose of filing taxes at the end of the year is to determineif a person has overpaid or underpaid their taxes102
105 Countries with the highest income tax rates CountryTax rateKicks in at….Aruba58.9%$165,000Sweden56.6%$81,000Denmark55.4%$76,000Netherlands52%$72,000Austria50%$80,000Belgium$46,900Japan$217,000United Kingdom$231,000Finland49.2%$91,000Ireland48%$43,900U.S. = 23rd; at 39.6% at $400, *Source: CNBC
106 Where does the State and local government spend money???
107 Where does the federal government spend money ? everything else includes education, veterans benefits, national resources, foreign aid, Immigration, response to natural disasters
108 Military spending around the world http://www. sipri
109 What is the national debt??? Debt occurs when government revenue (primarily from taxes) is less than government spending.Therefore debt will rise whenever..revenue fallsspending increases
110 Debt in the past decade DEBT CLOCK 2001: $5.8 trillion2002: $6.2 trillion2003: $6.8 trillion2004: $7.4 trillion2005: $7.9 trillion2006: $8.5 trillion2007: $9.0 trillion2008: $10.0 trillion2009: $11.9 trillion2010: $13.6 trillionDEBT CLOCKIt would take 200,000 years to count to 1 trillion!!!!!
111 Countries with the largest debts Source: David Colander - Macroeconomics17-111
112 Countries with largest debt as compared to GDPs
114 Congressional Committees As a group, analyze the situation, identify the problem, and identify your solutionThe Good, the Bad, and the UglyUnemploymentInflationGDP GrowthGood6% or less1%-4%2.5%-5%Worry6.5%-8%5%-8%1%-2%Bad8.5 % or more9% or more.5% or less
115 1.) 1933 Situation: GDP fell -1.2% Inflation rate= -.5% Unemployment Rate=25%Your Solution:What actually happened:FDR increased public works via the New Deal programs.
116 2.) 1944 Situation: GDP grew 8% Inflation rate= 3.7% Unemployment Rate=1.2%Your Solution:What actually happened:War ended the next year and government orders for war materials decreased.Many public works programs were discontinued
117 3.) 1980 Situation: GDP fell -0.3% Inflation rate= 13.5% Unemployment Rate=7.1%Your Solution:What actually happened:The next year, President Regan and congress lowered taxes on individuals and corporations by about 30%. (Supply-side Economics)
118 4.) 2003 Situation: GDP fell 0.5% Inflation rate= 1.5% Unemployment Rate=12.0%Your Solution:What actually happened:Congress voted to give tax cuts to citizens. (Bush Tax Cuts)