1. Feb 20, 2015 HW Check – Recessions in U.S. History
Grades are posted. Let me know of any errors. I submit grades next Mon.
Assembly seating: far right facing the stage, rows B-E
Tonight’s HW
Aggregate Supply and Demand Practice

2. Recessions in U.S. History
Which recession is the most severe? Why? Explain.
Similarities?
Oil , ,
Speculative Bubbles (housing bubble), (dot-com bubble), The Great Depression (stock bubble)
High interest rates/Fed's monetary policy ,
, , The Great Depression
Differences?
Stagflation ,

3. Unit 2: Economic Fluctuations and Fiscal Policy

4. Aggregate Supply and Demand Model
The AS-AD model helps us understand economic fluctuations.
Aggregate = added all together; combining all prices and all quantities.
Aggregate Demand – total consumption by entire population for all goods and services
Aggregate Supply –total output (total production of all goods and services).
Price
Level
LRAS
SRAS AD
Real GDP

5. Aggregate Demand

6. What is Aggregate Demand?
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.
Inverse relationship between price level and Real GDP.
If the price level:
Increases (Inflation), then real GDP demanded falls.
Decreases (deflation), the real GDP demanded increases.

7. Aggregate Demand Curve
Price
Level
AD is the demand by consumers, businesses, government, and foreign countries
Changes in price level cause a move along the curve AD
= C + I + G + Xn
Real domestic output (GDPR)

8. Why is AD downward sloping?
Wealth Effect-
Higher price levels reduce the purchasing power of money
This decreases the quantity of expenditures
Lower price levels increase purchasing power and increase expenditures
Example:
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.

9. Why is AD downward sloping?
2. Interest-Rate Effect
When 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 expand your business.
Result…Price Level goes up, GDP demanded goes down (and Vice Versa).
The interest rate effect – as the price level increase, purchasing power decrease and as a result, people either save less or must borrow more to maintain their consumption. This reduced the supply of loanable money drives up the interest rate. As the interest rate increases, business buy less capital and consumers buy fewer durable good.

10. Why is AD downward sloping?
3. Net Export Effect
When U.S. price level rises, foreign buyers purchase fewer U.S. goods and Americans buy more foreign goods
Exports 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. Determinants/Shifters of Aggregate Demand
GDP = C + I + G + Xn

12. Shifts in Aggregate Demand
Price
Level
An increase in spending will shift AD right, and decrease in spending shifts it left
AD1 AD
= C + I + G + Xn
AD2
Real domestic output (GDPR) 12

13. Shifters of Aggregate Demand
Change in Consumer Spending
Consumer Wealth (Boom in the stock market…)
Consumer Expectations (People fear a recession…)
Interest Rate (Increase/decrease cost of borrowing…)
Taxes (Decrease in income taxes…)
2. Change in Investment Spending
Interest Rate (Increase/decrease cost of borrowing…)
Future Business Expectations (Optimistic…)
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
AD = GDP = C + I + G + Xn

15. Aggregate Demand
Consumers respond to high levels of debt by reducing their purchases of consumer goods. Component of AD? Change in AD? Increase or decrease? Resulting AD shift?
Price
Level
Consumption AD
Real GDP

16. How does this cartoon relate to Aggregate Demand?

17. How does this cartoon relate to Aggregate Demand?

18. Aggregate Supply

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.
AS depends on the quantity of labor and capital and the level of technology.
Aggregate Supply differentiates between short run and long-run and has two different curves.
Short-run Aggregate Supply
Wages and Resource Prices will not increase as price levels increase.
Long-run Aggregate Supply
Wages and Resource Prices will increase as price levels increase.

20. Refresher…
In the short run, at least one input is fixed.
The long run is a period of time long enough for firms to change any of their inputs, thus all costs are variable.

21. Short-Run Aggregate Supply
In the short run, wages and resource prices will NOT increase (“sticky”) 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 = $20
What happens in the SHORT-RUN if price level doubles?
Now 100 units sell for $2, TR=$200. How much is profit?
Profit = $120
With higher profits, the firm has the incentive to increase production.

22. AS is upward sloping bc
In the short run, many costs that producers face are fixed. The largest fixed cost tends to be wages paid to workers. Wages are often determined by contracts and even when they are not, employers are slow to increase or decrease them in response to economic conditions. When the price level rises, the production costs do not rise by the same proportion as the rise in the price of the unit so profits tend to rise in the short run. Higher profits incentivize producers to increase output.

23. Aggregate Supply Curve
Price
Level AS
AS is the production of all the firms in the economy
Real domestic output (GDPR) 23

24. Long-Run Aggregate Supply (potential Real GDP)
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=$200
In the LONG RUN workers demand higher wages to match prices. So labor costs double to $160
Profit = $40, but REAL profit is unchanged.
If REAL profit doesn’t change
the firm has no incentive to increase output.
Output is determined by the resources that exist in the economy  full employment

25. Long run Aggregate Supply
In Long Run, price level increases but GDP doesn’t
LRAS
Price level
Long-run
Aggregate
Supply
Full-Employment
(Trend Line) QY
GDPR
In the long run the economy will be producing at full employment.
Natural level of real GDP

26. Shifts in Aggregate Supply
An increase or decrease in national production can shift the curve right or left
AS2
Price
Level AS
AS1
Real domestic output (GDPR) 26

27. Determinants/ Shifters Aggregate Supply
R. A. P.
1. Change in Resource (labor, capital) Prices
Prices 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…) 27

28. Shifters of Aggregate Supply (NOT Government Spending)
2. Change in Actions of the Government
(NOT Government Spending)
Taxes on Producers
(Lower corporate taxes…)
Subsidies for Domestic Producers
(Lower subsidies for domestic farmers…)
Government Regulations
(EPA inspections required to operate a farm…)
3. Change in Productivity
Technology
(Computer virus that destroy half the computers…)
Human Capital

29. Aggregate Supply
Unions are more effective so that wage rates increase. Determinant of AS? Input costs or productivity? Change in AS? Increase or decrease? Resulting AS curve?
Price
Level AS
Real GDP

30. What causes Business Cycles?
Partner Discussion Using the info from the Recession in U.S History handout, answer the following: 1. What factors might cause spending (AD) in the economy to change? 2. What factors would increase or decrease production (AS)?

31. Putting AD and AS together to get Equilibrium Price Level and Output

32. Aggregate Supply and Demand Model
Business investment increases Real GDP Price Level Unemployment AS
Price
Level AD
Real GDP

33. Shifters of Aggregate Demand Shifters of Aggregate Supply
AD = C + I + G + X
Change in Consumer Spending
Change in Government Spending
Change in Investment Spending
Net EXport Spending
Shifters of Aggregate Supply
AS = R + A + P
Change in Resource Prices
Change in Actions of the Government
Change in Productivity (Investment)

34. Inflationary and Recessionary Gaps34

35. LRAS PL and Q will Increase
Example: Assume the government increases spending. What happens to PL and Output?
LRAS
Price Level AS
PL and Q will Increase
PL1
PLe
AD1 AD QY Q1
GDPR 35

36. Inflationary Gap LRAS Actual GDP above potential GDP
Output is high and unemployment is less than NRU
LRAS
Price Level AS
Actual GDP above potential GDP
PL1
AD1 QY Q1
GDPR 36

37. Stagnate Economy + Inflation
Example: Assume the price of oil increases drastically. What happens to PL and Output?
LRAS
Price Level
AS1 AS
PL1
Stagflation
Stagnate Economy + Inflation
PLe AD Q1 QY
GDPR 37

38. Recessionary Gap LRAS Actual GDP below potential GDP
Output low and unemployment is more than NRU
LRAS
Price Level
AS1
Actual GDP below potential GDP
PL1 AD Q1 QY
GDPR 38

39. Short Run and Long Run 39

40. Shifts in AD or AS change the price level and output in the short run
LRAS
Price Level AS
PLe AD QY
GDPR 40

41. Example: Assume consumers increase spending
Example: Assume consumers increase spending. What happens to PL and Output?
LRAS
Price Level AS
PL1
PLe
AD1 AD QY Q1
GDPR 41

42. Now, what will happen in the LONG RUN?
Inflation means workers seek higher wages and production costs increase
LRAS
Price Level
AS1 AS
PL2
Back to full employment with higher price level
PL1
PLe
AD1 AD QY Q1
GDPR 42

43. AS increases as workers accept lower wages and production costs fall
Example: Consumer expectations fall and consumer spending plummets. What happens to PL and Output in the Short Run and Long Run?
Price Level
LRAS AS
AS1
AS increases as workers accept lower wages and production costs fall
PLe
PL1
Short Run -AD Falls, PL and Q fall
Long Run- AS Increases as workers accept lower wages and production costs fall. PL goes down, Q goes back to Full Employment
PL2 AD AD
AD1 Q1 QY
GDPR 43

44. Positive economic growth results from an increase in productive resources, such as labor and capital. With more resources, it is possible to produce more final goods and services, and hence, the natural level of real GDP increases. Positive economic growth is therefore represented by a shift to the right of the LAS curve. Similarly,negative economic growth decreases the natural level of real GDP, causing the LAScurve to shift to the left.

45. Homework
2008 Recession reading packet. You need to answer the questions at the end of each reading.
1. Taking Out a Mortgage – Prime vs. Subprime
2. Nicole Bradury, Robo-Signer Victim
3. Rise and Fall of Bubbles

46. Federal Funds Rates
May 17, 2013 rate: 0.15%

49. Discussion Qs
What should the government do to address the 2008 financial crisis? Should the US government bail out the banking/financial/insurance industry?

50. Bailout Spending (as of 5/23/13)
929 Recipients
Total disbursement = $606 billion
Total returned = $364 billion
Total revenues from dividends, interest, and other fees = $116 billion
Total net to date = $-126 billion

51. Bailout Tracker
tracker/
dex.html
Recovery Act Spending

52. Table 3-1.1, Changes in AD A – “reducing purchases” C Decrease, left
Component of AD
Direction of AD
Resulting Curve
A – “reducing purchases” C
Decrease, left
AD2
B – “reduction in investment” I
C – “Gov’t spending increases” G
Increase, right
AD1
D – “Consumer confidence jumps”
E – “investors lose billions”
I, C
F – “productivity rises”
N/A
NC, it affects AS AD
G – “trade war that reduces exports by more than it reduces imports” Xn

53. Table 3-1.1, Changes in AS A – “wage rates increase” Input Costs
Determinant of AS
Change in AS
Resulting Curve
A – “wage rates increase”
Input Costs
Decrease, left
AS1
B – “increase oil prices”
C – “labor productivity increases”
Productivity
Increase, right
AS2
D – “gas discovery decreases energy prices”
E – “new efficiency”
F – “Gov’t spending increases”
N/A
NC (affects AD) AS
G – “save and invest” NC
H - “Low birth rate decrease the LF”
NC (until the future)
I – “increased skills”

54. Changes in SRAS and AD Shift in AD/AS Shift Effect on Price Level
Effect on Real GDP
1. Business investment increases AD
right
increase
2. Gov’t increases spending
Right
Increase
3. Oil discovery causes decrease in price AS
Decrease
4. Consumer spending increases
5. Production costs increase
Left
6. New tech and better education increase productivity.
7. Consumer confidence increases
8. Net exports decrease
9. “Economic boom in Japan and Europe”
10. “reduce taxes and increase transfer payments”
11. “highest corn and wheat yields”
12. “defense spending was increased”
13. “cuts SS by 10% and fin-aid by 20%”
14. “Begin to buy…to replace failing models’

55. Recessions in U.S. HistoryAS
Draw AD-AS models for each of the recessions.
Price
Level AD
Real GDP

56. Causes of the 2008 Financial Crisis
2001 Recession Fed lowers interest rates Low interest rates make it cheaper to buy a home INCREASES DEMAND FOR HOMES Subprime loans made home buying more accessible to more individuals
, average home prices more than doubles
Investment banks  SECURIZATION  Mortgage-backed Securities (CDOs)

57. 2008 Financial Crisis
The Crisis of Credit Visualized 1. Why did America experience a housing boom? 2. How did investment bankers make so much money? 3. How would you assign blame (mortgage lenders, mortgage borrowers, the Federal Reserve?) for the housing market collapse and financial crisis that followed? Why? Any questions?

58. NBER: Effects of the Financial Crisis and Great Recession on American Households
We find that the effects of the recession are widespread: between November 2008 and April about 39 percent of households had either been unemployed, had negative equity in their house or had been in arrears in their house payments. Reductions in spending were common especially following unemployment. On average expectations about stock market prices and housing prices are pessimistic, particularly long-run expectations. Among workers, expectations about becoming unemployed have recovered somewhat from their low point in May 2009 but still remain high. Overall the data suggest that households are not optimistic about their economic futures.
- Sept, 2010
2008 Financial Crisis
Dec, June 2009
Peak to trough – 18 months

62. https://www. youtube. com/watch
HVcIlHGc&list=UUOBwTuxW6hWHiR0Bw9pppIQ

64. Circular Flow and GDP Practice KEY
b. $800 million (C+I+G+X-M or wages+dividends+interest+rent) c. Disposable income = $670 d. Household savings = $270 e. no, gov’t had to borrow $70 million f. $290m (borrowing) = $290 (household savings & foreign lending) g. $800m (goes into product market) = $800m (goes into factor market) h. $800m (goes into factor market) = $800 (household income)

65. #2 Included - investment spending
Not included – house was built in 2001 – used and no realtor = no income.
Included – gov’t spending
Included – exports
Not included – non-market transaction
Included - investment

66. #3
Calculating Nominal and Real GDP a = $8, = $8, = $9,650 b. 10.8% (( )/8000)*100 c. 8.8% (( )/8866)*100
d = 8,000
2011 = 8,650
2012 = 9,070
e. 8.1%
(( )/8000)*100
f. 4.9%
(( )/8650)*100
g = 100
2011 = 102.5
2012 = 106.4