Presentation on theme: "Introduction to Macroeconomics"— Presentation transcript:
1 Introduction to Macroeconomics Chapter 23.Aggregate Demand and Aggregate Supply
2 Classical model (chapter 21) A RecapClassical model (chapter 21)vertical aggregate supply curveperfectly flexible interest rate and pricesequilibrium always at full employmentKeynesian Model (chapter 22)horizontal aggregate supply curvefixed (sticky) interest rates and pricesequilibrium with unemploymentAn Intermediate Model (chapter 23)upward sloping aggregate supply curveflexible interest rates and prices
3 Aggregate Demand and Aggregate Supply 1. Price Changes and Aggregate Demand2. Aggregate Demand Curve3. Aggregate Supply Curve4. Supply-Demand Equilibrium
4 1. Price Changes and Aggregate Demand Wealth and Interest Rate Effects
5 1. Price Changes and Aggregate Demand Types of Wealth Monetary (Pecuniary) - cash, checking and savings accounts. Real value declines with inflation.Non-Monetary (Nonpecuniary) - physical assets whose nominal value increases with inflation. Real value does not change with inflation.
6 1. Price Changes and Aggregate Demand Wealth - Purchasing Power Monetary wealth (cash and savings): As average price level goes up, cash and checking account balances don’t change. Purchasing power (real value) of monetary assets declines.Nonmonetary wealth unaffected by changes in the average price level. As average price level goes up, price of nonmonetary assets (e.g., house) also goes up. Real value unchanged.
7 1. Price Changes and Aggregate Demand Wealth - Real Money Balances Real Money Balances = Nominal money balances (cash and savings) corrected for inflation.With inflation:Nominal money balances unchangedReal money balances decline
8 1. Price Changes and Aggregate Demand Wealth (Real Balance) Effect Consumption is a positive function of income and wealthIncrease in average level of pricesReduces purchasing power of existing monetary wealth (nonpecuniary wealth unaffected)Decline in consumptionKeynesian aggregate expenditure curve shifts downward
9 1. Price Changes and Aggregate Demand Wealth (Real Balance) Effect C1 + I + G + NX (P1 < P0)C0 + I + G + NX (P = P0)C2 + I + G + NX (P2 > P0)45oIncomeY2Y0Y1
10 1. Price Changes and Aggregate Demand Interest Rate Effect - Part 1 Real interest rate is positively related to the average price level:prices increase (inflation)decline in real money balancesincrease in demand for cash in order to restore real money balancesreal interest rates increase to reduce the demand for real money balances and cash (i.e., return the demand and supply for money to equilibrium)
11 1. Price Changes and Aggregate Demand Interest Rate Effect - Part 2 Investment negatively related to real interest rate and average price level:price increase (inflation)real interest rate increasesinvestment declinesKeynesian expenditure curve shifts downward
12 1. Price Changes and Aggregate Demand Interest Rate Effect C + I1 + G + NX (P1 < P0)C + I0 + G + NX (P = P0)C + I2 + G + NX (P2 > P0)45oIncomeY2Y0Y1
13 1. Price Changes and Aggregate Demand Wealth and Interest Rate Effects Increase in average level of prices:Wealth Effect - decline in consumption and decline in aggregate expendituresInterest Rate Effect - increase in real interest rate, decline in investment and decline in aggregate expenditures.
14 2. Aggregate Demand Curve Negative relationship between total expenditures and average price level (downward sloping)
15 2. Aggregate Demand Curve Deriving the Aggregate Demand Curve Keynesian Expenditure Curve (Chapter 22) - positive relationship between total spending and income at a given fixed price level.Aggregate Demand Curve - negative relationship between income (total expenditures) and average level of prices
16 2. Aggregate Demand Curve Deriving the Aggregate Demand Curve Refer to Figure 23.4 in textbook
17 2. Aggregate Demand Curve Aggregate Demand Curve Slope Flat demand curve: large response by expenditures to wealth and interest rate effects. A small change in price leads to a large change in demand.Steep demand curve: small response by expenditures to wealth and interest rate effects.
18 2. Aggregate Demand Curve Aggregate Demand Curve Shift AD = C + I + G + NXAggregate demand curve shifts to the right when:increase in autonomous spending (C0, I0, G0)increase in net exports (NX)reduction in taxes (increase disposable income and consumption)Note: a change in the average price level does not imply a shift in the demand curve, but a movement along (up or down) a stationary demand curve
19 3. Aggregate Supply Curve Relationship between total output and average price level
20 3. Aggregate Supply Curve Aggregate Supply Curve Slope Classical Range - vertical at full employment outputKeynesian Range - horizontal at a fixed price levelIntermediate Range - upward sloping
21 3. Aggregate Supply Curve Aggregate Supply Curve Shift Aggregate supply curve shifts to the right (increases) when:increase in productivity (e.g., new technology)increase in resources (e.g., increased level of investment and capital stock)reduction in real cost of inputs to production process (e.g., wage rate or raw material costs decline relative to average price level)
22 4. Supply-Demand Equilibrium Aggregate Demand Curve Shift Effect of an increase in Aggregate Demand
23 4. Supply-Demand Equilibrium Aggregate Supply Curve Shift Effect of an increase in Aggregate Supply