Chapter 19 Aggregate Demand and Supply Interactive Examples Aggregate Demand and Supply Begin To navigate, please click the appropriate green buttons. (Do not use the arrows on your keyboard) Material from this presentation can be found in: Chapter 19 Slides Created By Kevin Brady and Eric Chiang CoreEconomics, 2e

Interactive Examples Aggregate Demand and Supply Next Aggregate Price Level (P) The aggregate demand (AD) and aggregate supply (AS) model is used to analyze the economy. It shows the relationship between aggregate output of goods and services in the economy and the price level. Aggregate Output (Y) Back

Question: Why is the AD curve negatively sloped? Interactive Examples Aggregate Demand and Supply Aggregate Price Level (P) The AD curve shows the output of goods and services demanded at different price levels. Question: Why is the AD curve negatively sloped? AD Aggregate Output (Y) Back Answer 3

Question: Why is the AD curve negatively sloped? Interactive Examples Aggregate Demand and Supply Next Aggregate Price Level (P) The AD curve shows the output of goods and services demanded at different price levels. Question: Why is the AD curve negatively sloped? Answer: The three main reasons are the 1. wealth effect 2. export effect 3. interest rate effect AD Aggregate Output (Y) Back 4

Question: What are the determinants of aggregate demand? Interactive Examples Aggregate Demand and Supply Aggregate Price Level (P) The determinants of aggregate demand are those factors that shift the entire aggregate demand curve when they change. Question: What are the determinants of aggregate demand? AD Aggregate Output (Y) Back Answer 5

Answer: They are the components of GDP. Consumer Spending Investment Interactive Examples Aggregate Demand and Supply Next Aggregate Price Level (P) The determinants of aggregate demand are those factors that shift the entire aggregate demand curve when they change. Question: What are the determinants of aggregate demand? Answer: They are the components of GDP. Consumer Spending Investment Government Spending Net Exports AD Aggregate Output (Y) Back 6

Interactive Examples Aggregate Demand and Supply Aggregate Price Level (P) Question: If the stock market rises significantly during the next year, what would happen to the aggregate demand curve? AD Aggregate Output (Y) Back Answer 7

Interactive Examples Aggregate Demand and Supply Next Aggregate Price Level (P) Question: If the stock market rises significantly during the next year, what would happen to the aggregate demand curve? P0 Answer: The aggregate demand curve would shift to the right. If the stock market rises, consumers will be wealthier, and they are willing to buy more at each price level. AD1 Notice that at price level P0, aggregate output was Y0. After the increase in aggregate demand, aggregate output increases to Y1 at the price level P0. AD0 Aggregate Output (Y) Y0 Y1 Back 8

Interactive Examples Aggregate Demand and Supply Aggregate Price Level (P) Question: Assume the graph to the right represents the U.S. economy. If foreign countries become richer, will this affect aggregate demand in the U.S.? AD Aggregate Output (Y) Back Answer 9

Interactive Examples Aggregate Demand and Supply Next Aggregate Price Level (P) Question: Assume the graph to the right represents the U.S. economy. If foreign countries become richer, will this affect aggregate demand in the U.S.? Answer: Yes! The aggregate demand curve would shift to the right. If foreign consumers are richer, they will spend more. Part of this spending will be on U.S. exports. AD1 AD0 Aggregate Output (Y) Back 10

Interactive Examples Aggregate Demand and Supply Aggregate Price Level (P) Question: If the government decides to raise taxes in order to reduce the budget deficit, what would happen to the aggregate demand curve? AD Aggregate Output (Y) Back Answer 11

Interactive Examples Aggregate Demand and Supply Next Aggregate Price Level (P) Question: If the government decides to raise taxes in order to reduce the budget deficit, what would happen to the aggregate demand curve? Answer: The aggregate demand curve would shift to the left. Higher taxes will leave less money for consumers to spend at each price level. AD0 AD1 Aggregate Output (Y) Back 12

Interactive Examples Aggregate Demand and Supply Next Aggregate Price Level (P) The aggregate supply curve shows the real GDP that firms will produce at varying price levels. We will need to make a distinction between the short-run aggregate supply curve (SRAS) and the long-run aggregate supply curve (LRAS). Aggregate Output (Y) Back 13

Let’s first begin with the SRAS curve. Interactive Examples Aggregate Demand and Supply Aggregate Price Level (P) Let’s first begin with the SRAS curve. SRAS Question: Why is the SRAS curve positively sloped? Aggregate Output (Y) Back Answer 14

Let’s first begin with the SRAS curve. Interactive Examples Aggregate Demand and Supply Next Aggregate Price Level (P) Let’s first begin with the SRAS curve. SRAS Question: Why is the SRAS curve positively sloped? Answer: The SRAS curve is positively sloped because some input costs are slow to change in the short run. For example, when prices rise, wages for workers do not automatically adjust upward. The result is higher profits for businesses, which in turn induces them to supply more output. Aggregate Output (Y) Back 15

Question: What are the determinants of short-run aggregate supply? Interactive Examples Aggregate Demand and Supply The determinants of the short-run aggregate supply curve are those factors that shift the entire aggregate supply curve when they change. Aggregate Price Level (P) SRAS Question: What are the determinants of short-run aggregate supply? Aggregate Output (Y) Back Answer 16

Productivity Taxes and Regulation Market Power of Firms Expectations Interactive Examples Aggregate Demand and Supply Next The determinants of the short-run aggregate supply curve are those factors that shift the entire aggregate supply curve when they change. Aggregate Price Level (P) SRAS Question: What are the determinants of short-run aggregate supply? Answer: There are five main determinants. Input Prices Productivity Taxes and Regulation Market Power of Firms Expectations Aggregate Output (Y) Back 17

Interactive Examples Aggregate Demand and Supply Aggregate Price Level (P) Question: If a new technology were developed that could extract twice the amount of energy from each barrel of oil, what would happen to the SRAS curve? SRAS0 Aggregate Output (Y) Back Answer 18

Interactive Examples Aggregate Demand and Supply Next Aggregate Price Level (P) Question: If a new technology were developed that could extract twice the amount of energy from each barrel of oil, what would happen to the SRAS curve? SRAS0 SRAS1 Answer: The SRAS curve would shift to the right. At each price level, suppliers would be willing to bring more goods to the market. P0 Notice that at price level P0, aggregate output was Y0. After the increase in aggregate supply, aggregate output increases to Y1 at the price level P0. Aggregate Output (Y) Y0 Y1 Back 19

Interactive Examples Aggregate Demand and Supply Aggregate Price Level (P) Question: If businesses expect the prices for their products to rise in the near future, what would happen to the SRAS curve? SRAS0 Aggregate Output (Y) Back Answer 20

Interactive Examples Aggregate Demand and Supply Next Aggregate Price Level (P) Question: If businesses expect the prices for their products to rise in the near future, what would happen to the SRAS curve? SRAS1 SRAS0 Answer: The SRAS curve would shift to the left. If companies think they can sell their products for more money in the near future, they will cut back on their current supply and wait to get better prices. Aggregate Output (Y) Back 21

Interactive Examples Aggregate Demand and Supply Aggregate Price Level (P) Question: If the President of the United States enacts tough new compliance laws for every company importing goods in order to minimize the risk of terrorist activity, would this affect the aggregate supply curve? SRAS0 Aggregate Output (Y) Back Answer 22

Interactive Examples Aggregate Demand and Supply Next Aggregate Price Level (P) Question: If the President of the United States enacts tough new compliance laws for every company importing goods in order to minimize the risk of terrorist activity, would this effect the aggregate supply curve? SRAS1 SRAS0 Answer: Yes, the SRAS curve would shift to the left. The new compliance laws will raise the costs of supplying goods, and therefore producers will bring less product to market for each given price level. Aggregate Output (Y) Back 23

Let’s introduce the long-run aggregate supply curve (LRAS). Interactive Examples Aggregate Demand and Supply Aggregate Price Level (P) Let’s introduce the long-run aggregate supply curve (LRAS). Question: What is the time period cutoff between the short run and the long run? Aggregate Output (Y) Back Answer 24

Let’s introduce the long-run aggregate supply curve (LRAS). Interactive Examples Aggregate Demand and Supply Next Aggregate Price Level (P) Let’s introduce the long-run aggregate supply curve (LRAS). Question: What is the time period cutoff between the short run and the long run? Answer: Trick question! In the current context, the difference between the short run and the long run has nothing to do with a time horizon. The difference is that in the short run prices are sticky and in the long run prices are flexible. Aggregate Output (Y) Back 25

Question: Why is the LRAS curve a vertical line? Interactive Examples Aggregate Demand and Supply Aggregate Price Level (P) Question: Why is the LRAS curve a vertical line? LRAS Aggregate Output (Y) Back Answer 26

Question: Why is the LRAS curve a vertical line? Interactive Examples Aggregate Demand and Supply Next Aggregate Price Level (P) Question: Why is the LRAS curve a vertical line? LRAS Answer: The LRAS is vertical at full employment because the economy has reached its maximum capacity to produce. Aggregate Output (Y) Back 27

Question: What are the determinants of the LRAS curve? Interactive Examples Aggregate Demand and Supply Aggregate Price Level (P) The determinants of the long-run aggregate supply curve are those factors that shift the entire LRAS curve when they change. LRAS Question: What are the determinants of the LRAS curve? Aggregate Output (Y) Back Answer 28

Question: What are the determinants of the LRAS curve? Interactive Examples Aggregate Demand and Supply Next Aggregate Price Level (P) The determinants of the long-run aggregate supply curve are those factors that shift the entire LRAS curve when they change. LRAS Question: What are the determinants of the LRAS curve? Answer: The determinants of the LRAS curve are resources productivity technology Aggregate Output (Y) Back 29

Interactive Examples Aggregate Demand and Supply Aggregate Price Level (P) Question: If the largest earthquake ever recorded struck the economy and made it impossible to extract certain vital natural resources, what would happen to the LRAS curve? LRAS Aggregate Output (Y) Back Answer 30

Interactive Examples Aggregate Demand and Supply Next Aggregate Price Level (P) Question: If the largest earthquake ever recorded struck the economy and made it impossible to extract certain vital natural resources, what would happen to the LRAS curve? LRAS1 LRAS0 Answer: The LRAS curve would shift to the left because the productive capacity of the economy would be smaller. Aggregate Output (Y) Back 31

Interactive Examples Aggregate Demand and Supply Aggregate Price Level (P) Question: What effect did the invention of the internet have on the LRAS curve? LRAS Aggregate Output (Y) Back Answer 32

Interactive Examples Aggregate Demand and Supply Next Aggregate Price Level (P) Question: What effect did the invention of the internet have on the LRAS curve? LRAS0 LRAS1 Answer: The LRAS curve shifted to the right as a result of the invention of the internet. The new technology made workers more productive and opened the door to new industries, both of which increased the productive capacity of the economy. Aggregate Output (Y) Back 33

We are now ready to discuss the concept of macroeconomic equilibrium. Interactive Examples Aggregate Demand and Supply Next Aggregate Price Level (P) We are now ready to discuss the concept of macroeconomic equilibrium. LRAS SRAS Short-run macroeconomic equilibrium occurs at the intersection of the SRAS and AD curves. Long-run macroeconomic equilibrium occurs at the intersection of the SRAS, AD, and LRAS curves. AD Aggregate Output (Y) Back 34

Interactive Examples Aggregate Demand and Supply Aggregate Price Level (P) Assume the economy is in long-run macroeconomic equilibrium at price level P0 and output level Y0. LRAS0 SRAS0 Question: If home prices across the economy rise, what will be the short-run and long-run effects in our model? P0 AD0 Aggregate Output (Y) Y0 Back Answer 35

Interactive Examples Aggregate Demand and Supply Aggregate Price Level (P) Question: If home prices across the economy rise, what will be the short-run and long-run effects in our model? SRAS1 LRAS0 SRAS0 P2 Answer: An increase in home values increases wealth. In the short run, this causes the AD0 curve to shift to the right to AD1. Note that the price level and output level have increased to P1 and Y1, respectively. P1 P0 AD1 Answer: In the long run, workers will feel the pressure of the increased prices and demand higher wages. This will cause the SRAS0 curve to shift to the left to SRAS1. Here a new equilibrium is reached at P2 and Y0. AD0 Aggregate Output (Y) Y0 Y1 Back Start Over 36