Chapter 19 Aggregate Demand and Aggregate Supply Principles of Economics by Fred M Gottheil PowerPoint Slides prepared by Ken Long 4/21/2017 ©1999 South-Western College Publishing

What is the Business Cycle? Alternating periods of growth and decline in an economy’s GDP ©1999 South-Western College Publishing

Aggregate Output Trough Peak The Business Cycle Time 3

What are the four stages of the Business Cycle? trough expansion peak recession ©1999 South-Western College Publishing

Aggregate Output Trough Peak The Business Cycle Time 5

Time Aggregate Output The Business Cycle Peak Recession Expansion Trough Time 6

What is a Recession? A phase in the business cycle in which the decline in the economy’s real GDP persists for at least 6 months ©1999 South-Western College Publishing

What is a Depression? A severe recession ©1999 South-Western College Publishing

What is Prosperity? A phase in the business cycle marked by a relatively high level of real GDP, full employment, and inflation ©1999 South-Western College Publishing

An increase in the price level What is Inflation? An increase in the price level ©1999 South-Western College Publishing

How do we measure Economic Growth? Gross Domestic Product ©1999 South-Western College Publishing

What is Gross Domestic Product? GDP is the total value of all final goods and services measured in current market prices, produced in the economy in any one year ©1999 South-Western College Publishing

What is a Final Good? A good that is not itself used to produce other goods ©1999 South-Western College Publishing

What does “measured in current market prices” mean? The year in which the good was made, the current market price ©1999 South-Western College Publishing

What does “produced in the economy” mean? It is produced domestically ©1999 South-Western College Publishing

For the latest measure of GDP visit - http://www.whitehouse.gov/fsbr/esbr.html http://www.bea.doc.gov ©1999 South-Western College Publishing

How do we make adjustments for prices? We measure both Nominal and Real GDP ©1999 South-Western College Publishing

What is Nominal GDP? GDP measured in terms of current market prices - it is not adjusted for inflation ©1999 South-Western College Publishing

What is Real GDP? GDP adjusted for changes in the price level ©1999 South-Western College Publishing

What is a Base Year? The reference year with which prices in other years are compared in a price index ©1999 South-Western College Publishing

What is the Price Level? A measure of prices in one year expressed in relation to prices in a base year ©1999 South-Western College Publishing

What is the Consumer Price Index? A measure comparing the prices of consumer goods and services that a household typically purchases compared to a base year ©1999 South-Western College Publishing

What is the value of the index in the base year? 100 ©1999 South-Western College Publishing

If nominal GDP is $750 billion and the price index for that year is 1 If nominal GDP is $750 billion and the price index for that year is 1.11, then real GDP = $750/1.11 (or) $675.68 ©1999 South-Western College Publishing

What is the Consumer Price Index (CPI)? A measure over time of the cost of a fixed ‘market basket’ of consumer goods and services ©1999 South-Western College Publishing

How does the GDP index compare with the CPI index? GDP uses a different basket of goods and services each year whereas the CPI uses a fixed basket determined in the base year ©1999 South-Western College Publishing

For the latest measure of CPI visit - http://stats.bls.gov/cpihome.htm http://woodrow.mpls.frb.fed.us/economy/calc/hist1913.html ©1999 South-Western College Publishing

What is the GDP Price Deflator? A measure comparing the prices of all goods and services produced in the economy during a given year to the prices of those goods and services purchased in a base year ©1999 South-Western College Publishing

Nominal GDP x 100 GDP Deflator Real GDP = Nominal GDP x 100 GDP Deflator 2929 ©1999 South-Western College Publishing

For current and historical data on production - http://www.bog.frb.fed.us/releases http://www.census.gov ©1999 South-Western College Publishing

What is Aggregate Demand? The total quantity of goods and services demanded by households, firms, foreigners, and government at varying price levels ©1999 South-Western College Publishing

Price Level AD Real GDP 32

What factors can explain the downward slope of Aggregate Demand? Real wealth effect Interest rate effect International trade effect ©1999 South-Western College Publishing

Real Wealth Effect As the price level rises, real purchasing power of some assets declines, thus may reduce spending

Interest Rate Effect A rise in the price level can raise interest rates, leading to less consumption and investment spending

International Trade Effect A rise in domestic prices relative to foreign prices will reduce exports, raise imports

What factors can cause a shift in Aggregate Demand? A change in ... government spending taxes income abroad expectations ©1999 South-Western College Publishing

What is Aggregate Supply? The total quantity of goods and services that firms are willing to supply at varying price levels ©1999 South-Western College Publishing

What is the Shape of the AS curve? Very controversial, different ways of viewing AS curve

One type of AS curve, 3 sections to it Horizontal section Upward sloping section Vertical section

Aggregate Supply Curve Price level AS Real GDP 41

Why is Aggregate Supply perfectly vertical at higher levels of GDP? Because all resources are fully employed beyond some level of GDP ©1999 South-Western College Publishing

Why is the Aggregate Supply Curve horizontal at low levels of GDP? Because so many resources are not used or are under utilized ©1999 South-Western College Publishing

Why is the AS Curve upward sloping at higher levels of GDP? Because we have run out of some resources so an increase in demand causes those prices to increase ©1999 South-Western College Publishing

Aggregate Supply Curve Price level AS Real GDP 45

What is Macroequilibrium? The level of real GDP and the price level that equate the aggregate quantity demanded and the aggregate quantity supplied ©1999 South-Western College Publishing

Shifts in the AD Curve Price level AS P2 AD2 P1 Real GDP AD1 47 Q1 Q2

Will any increase in demand cause inflation? It depends on where the aggregate demand curve falls on the aggregate supply curve No! ©1999 South-Western College Publishing

Aggregate Supply Curve AS Price level AD4 AD3 AD2 AD1 Real GDP 49

Shifts in the AS Curve Price level AS1 AS2 P2 P1 Real GDP AD1 50 Q2 Q1

What factors can cause a shift in Aggregate Supply? A change in ... resource availability wages interest rates rents ©1999 South-Western College Publishing

What is an example of AD moving along a horizontal AS Curve? Roosevelt’s New Deal programs in the 1930’s and war related spending after 1939 ©1999 South-Western College Publishing

What is an example of AD moving along a positive AS Curve? Spending on the Viet Nam War in the 1960’s ©1999 South-Western College Publishing

What is Demand Pull Inflation? Inflation caused primarily by an increase in aggregate demand ©1999 South-Western College Publishing

What is an example of a decrease in Aggregate Supply? The OPEC legacy of the 1970’s ©1999 South-Western College Publishing

What is Cost-Push Inflation? Inflation cause primarily by a decrease in aggregate supply ©1999 South-Western College Publishing

What other problem can Cost-Push Inflation cause? Unemployment ©1999 South-Western College Publishing

What is Stagflation? A period of stagnating real GDP, inflation, and relatively high levels of unemployment ©1999 South-Western College Publishing

For current wealth and income data - http://www.whitehouse.gov/fsbr/income.html http://www.bea.doc.gov ©1999 South-Western College Publishing

What is a Recession? What is a Depression? What are the four stages of the Business Cycle? What is Gross Domestic Product? What is Nominal GDP? What is Real GDP?

What is the Consumer Price Index? What is the GDP Price Deflator? What is Aggregate Demand? What is Aggregate Supply? What is Macroequilibrium? What is Stagflation?