Presentation on theme: "Aggregate Demand and Supply"— Presentation transcript:
1 Aggregate Demand and Supply Rittenberg MacroeconomicsChapter 7Aggregate Demand and Supply
2 Why the Aggregate Demand Curve Slopes Downward (1) Aggregate demand (AD) is the economy-wide demand for goods and services.Like the market demand curve, the aggregate demand curve slopes downward, but for different reasons.The reasons for its downward slope are price-level effects:Wealth Effect (Real Wealth/Real Balances)Interest Rate EffectInternational Trade Effect (Substitution)
3 1.1 The Slope of the Aggregate Demand Curve Aggregate demand is the relationship between the total quantity of goods and services demanded (from all the four sources of demand) and the price level, ceteris paribus.The aggregate demand curve is a graphical representation of aggregate demand.The wealth effect is the tendency for a change in the price level to affect real wealth and thus alter consumption.
4 1.1 The Slope of the Aggregate Demand Curve The interest rate effect is the tendency for a change in the price level to affect the interest rate and thus to affect the quantity of investment demanded.The international trade effect is the tendency for a change in the price level to affect net exports.The change in the aggregate quantity of goods and services demanded refers to a movement along an aggregate demand curve in response to a change in price level, ceteris paribus.
5 1.2 Changes in Aggregate Demand A Change in aggregate demand is a change in the aggregate quantity of goods and services demanded at every price level. This can be caused by changes in…Consumption,Investment,Government purchases,Net exports.The exchange rate is the price of a currency in terms of another currency or currencies.
6 Why the Aggregate Demand Curve Slopes Downward (2)
10 Factors that Affect AD AD = C + I + G + XN Consumption Investment IncomeWealthExpectationsDemographicsTaxesInvestmentInterest RatesTechnologyCost of Capital GoodsCapacity UtilizationGovernment purchasesNet ExportsDomestic & Foreign IncomeDomestic & Foreign PricesExchange RatesGovernment Policy
15 The Multiplier EQUATION 1.1 The multiplier is the ratio of the change in the quantity of real GDP demanded at each price level to the initial change in one or more components of aggregate demand that produced it.EQUATION 1.1Multiplier = Δ (real GDP demanded at each price level)initial Δ (component of AD)EQUATION 1.2Δ (real GDP demanded at each price level) = Multiplier × initial Δ (component of AD)
16 Effect of initial increase in net exports without multiplier effect The MultiplierEffect of initial increase in net exports without multiplier effectAD1AD2
17 Effect of initial decrease in net exports without multiplier effect The MultiplierEffect of initial decrease in net exports without multiplier effectAD2AD1
19 2. AGGREGATE DEMAND AND AGGREGATE SUPPLY: THE LONG RUN AND THE SHORT RUN Learning ObjectivesDistinguish between the short run and the long run, as these terms are used in macroeconomics.Draw a hypothetical long-run aggregate supply curve and explain what it shows about the natural levels of employment and output at various price levels, given changes in aggregate demand.Draw a hypothetical short-run aggregate supply curve, explain why it slopes upward, and explain why it may shift; that is, distinguish between a change in the aggregate quantity of goods and services supplied and a change in short-run aggregate supply.Discuss various explanations for wage and price stickiness.Explain and illustrate what is meant by equilibrium in the short run and relate the equilibrium to potential output.
20 2. AGGREGATE DEMAND AND AGGREGATE SUPPLY: THE LONG RUN AND THE SHORT RUN The short run in macroeconomic analysis, is a period in which wages and some other prices are sticky and do not respond to changes in economic conditions.A sticky price is a price that is slow to adjust to its equilibrium level, creating sustained periods of shortage or surplus.The long run in macroeconomic analysis, is a period in which wages and prices are flexible.
21 Short-run Aggregate Supply Aggregate Supply (AS) is the total of all the firm (market) supply curves.It shows the quantity of real GDP produced at different price levels.Like Supply at the microeconomic level, it is a positive, upward-sloping curve
22 Short-run Aggregate Supply Short-run AS slopes upward because an increase in the price level (while production costs (wages) and capital are held constant on the short-run), means higher profit margins—firms will want to produce more.The reverse is true when price level falls….Sticky Prices: esp. Sticky Wages: Changes in Nominal Wages tend to lag behind changes in price level. This leads to a short term effective change in REAL WAGE.
24 Shape of Short-run AS (SRAS) In the short-run, the capital stock (the number of factories and machines, etc.) are held constant.Increasing the number of workers increases output, but at a diminishing rate.Diminishing returns manifest as an ever-steeper SRAS curve.In the short-run, some prices do not adjust quickly; they are “sticky”:Labor Costs (wages)Contracted supplies“Sticky” prices effect the short-run equillibrium
26 The Shape of Long-run AS (LRAS) Resource costs are NOT fixed.As prices rise, workers will want higher wages and will eventually get them.The amount of capital is not fixed—firms can build new plants and buy new equipment over the long-run.In the long-run, AS is set by the production possibilities curve—the capacity of the economy, and is not affected by prices, hence is vertical.
27 2.1 The Long RunThe long run aggregate supply (LRAS) curve is a graphical representation that relates the level of output produced by firms to the price level in the long run.
33 2.2 The Short RunThe short run aggregate supply (SRAS) curve is a graphical representation of the relationship between production and the price level in the short run.A change in the aggregate quantity of goods and services supplied is characterized by movement along the short-run aggregate supply curve.A change in short-run aggregate supply is characterized by a change in the aggregate quantity of goods and services supplied at every price level in the short-run.