Presentation on theme: "Unit 3: Aggregate Demand and Supply and Fiscal Policy"— Presentation transcript:
1 Unit 3: Aggregate Demand and Supply and Fiscal Policy
2 Demand and Supply Review Define Demand and the Law of Demand.Identify the three concepts that explain why demand is downward sloping.Identify the difference between a change in demand and a change in quantity demanded.Identify the Shifters of Demand.Define Supply and the Law of Supply.Why is supply upward sloping?Identify the Shifters of Supply.What does it mean if there is a perfectly inelastic supply curve?Name 10 famous male actors.
5 What is Aggregate Demand? Aggregate means “added all together.”When we use aggregateswe combine all prices and all quantities.Aggregate Demand is all the goods and services (real GDP) that buyers are willing and able to purchase at different price levels.The Demand for everything by everyone in the US.There is an inverse relationship betweenprice level and Real GDP.If the price level:Increases (Inflation), then real GDP demanded falls.Decreases (deflation), the real GDP demanded increases.
6 Aggregate Demand Curve AD is the demand by consumers, businesses, government, and foreign countriesPriceLevelWhat definitely doesn’t shift the curve?Changes in price level cause a move along the curveAD= C + I + G + XnReal domestic output (GDPR)
7 Why is AD downward sloping? Real-Balance Effect-Higher price levels reduce the purchasing power of moneyThis decreases the quantity of expendituresLower price levels increase purchasing power and increase expendituresExample:If the balance in your bank was $50,000, but inflation erodes your purchasing power, you will likely reduce your spending.So…Price Level goes up, GDP demanded goes down.
8 Why is AD downward sloping? 2. Interest-Rate EffectWhen the price level increases, lenders need to charge higher interest rates to get a REAL return on their loans.Higher interest rates discourage consumer spending and business investment. WHY?Example: An increase in prices leads to an increase in the interest rate from 5% to 25%. You are less likely to take out loans to improve your business.Result…Price Level goes up, GDP demanded goes down (and Vice Versa).
10 Why is AD downward sloping? 3. Foreign Trade EffectWhen U.S. price level rises, foreign buyers purchase fewer U.S. goods and Americans buy more foreign goodsExports fall and imports rise causing real GDP demanded to fall. (XN Decreases)Example: If prices triple in the US, Canada will no longer buy US goods causing quantity demanded of US products to fall.Again, Price Level goes up, GDP demanded goes down (and Vice Versa).
11 Shifters of Aggregate Demand GDP = C + I + G + Xn
12 Shifts in Aggregate Demand An increase in spending shift AD right, and decrease in spending shifts it leftPriceLevelAD1AD= C + I + G + XnAD2Real domestic output (GDPR)12
13 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…)Taxes (Decrease in income taxes…)2. Change in Investment SpendingReal Interest Rates (Price of borrowing $)(If interest rates increase…)(If interest rates decrease…)Future Business Expectations (High expectations…)Productivity and Technology (New robots…)Business Taxes (Higher corporate taxes means…)
14 Shifters of Aggregate Demand Change in Government Spending(War…)(Nationalized Heath Care…)(Decrease in defense spending…)Change in Net Exports (X-M)Exchange Rates(If the us dollar depreciates relative to the euro…)National Income Compared to Abroad(If a major importer has a recession…)(If the US has a recession…)If dollar depreciates, more Europeans will buy US products causing Net Exports to increase“If the US get a cold, Canada gets Pneumonia”AD = GDP = C + I + G + Xn14
15 How does this cartoon relate to Aggregate Demand?
16 How does this cartoon relate to Aggregate Demand?
19 What is Aggregate Supply? The supply for everything by all firms. Aggregate Supply is the amount of goods and services (real GDP) 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.Short-run Aggregate SupplyWages and Resource Prices will not increase as price levels increase.Long-run Aggregate SupplyWages and Resource Prices will increase as price levels increase.19
20 Short-Run Aggregate Supply In the Short Run, wages and resource prices will NOT increase as price levels increase.Example: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.Profit = $120With higher profits, the firm has the incentive to increase production.20
21 Aggregate Supply Curve PriceLevelASAS is the production of all the firms in the economyReal domestic output (GDPR)21
22 Long-Run Aggregate Supply In the Long Run, wages and resource prices WILL increase as price levels increase.Same Example:The firm has TR of $100 an uses $80 of labor.Profit = $20.What happens in the LONG-RUN if price level doubles?Now TR=$200In the LONG RUN workers demand higher wages to match prices. 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.22
23 Long run Aggregate Supply In Long Run, price level increases but GDP doesn’tLRASPrice levelLong-runAggregateSupplyFull-Employment(Trend Line)QYGDPRWe also assume that in the long run the economy will be producing at full employment.23
25 Shifts in Aggregate Supply An increase or decrease in national production can shift the curve right or leftAS2PriceLevelASAS1Real domestic output (GDPR)25
26 Shifters of Aggregate Supply Change in Inflationary ExpectationsIf an increase in AD leads people to expect higher prices in the future. This increases labor and resource costs and decreases AS.(If people expect lower prices…)2. Change in Resource PricesPrices of Domestic and Imported Resources(Increase in price of Canadian lumber…)(Decrease in price of Chinese steel…)Supply Shocks(Negative Supply shock…)(Positive Supply shock…)26
27 Shifters of Aggregate Supply (NOT Government Spending) Change in Actions of the Government(NOT Government Spending)Taxes on Producers(Lower corporate taxes…)Subsides for Domestic Producers(Lower subsidies for domestic farmers…)Government Regulations(EPA inspections required to operate a farm…)Change in ProductivityTechnology(Computer virus that destroy half the computers…)(The advent of a teleportation machine…)27
28 Released Exam Question The short-run aggregate supply curve is likely to shift to the left when there is an increase inThe cost of productive resourcesProductivityThe money supplyThe federal budget deficitImports
29 Released Exam Question 78% of test takers got this right in 2000 The short-run aggregate supply curve is likely to shift to the left when there is an increase inThe cost of productive resourcesProductivityThe money supplyThe federal budget deficitImports
30 Released Exam Question 2. Which of the following would most likely cause a rightward shift in an economy’s aggregate supply curve?A. An increase in interest rates.B. A tax increase of 50 cents per gallon for gasoline.C. An across-the-board reduction of wages in the manufacturing sector.D. The passage of legislation mandating a reduction in automobile pollution.E. The shutdown of plants and movement of production of goods abroad.
31 Released Exam Question Only 58% of test takers got this one right in 2000 2. Which of the following would most likely cause a rightward shift in an economy’s aggregate supply curve?A. An increase in interest rates.B. A tax increase of 50 cents per gallon for gasoline.C. An across-the-board reduction of wages in the manufacturing sector.D. The passage of legislation mandating a reduction in automobile pollution.E. The shutdown of plants and movement of production of goods abroad.