Unit 3: Aggregate Demand and Supply and Fiscal Policy 1 Copyright ACDC Leadership 2015

Shifters of Aggregate Demand Change in C onsumer Spending Change in I nvestment Spending Change in G overnment Spending Net E X port Spending AD = C + I + G + X Shifters of Aggregate Supply AS = R + A + P Change in R esource Prices Change in A ctions of the Government Change in P roductivity 2 Copyright ACDC Leadership 2015

Putting AD and AS together to get Equilibrium Price Level and Output 3 Copyright ACDC Leadership 2015

Price Level 4 AD AS GDP R QYQY PL e LRAS Use the AD and AS model to show an economy at full employment output Copyright ACDC Leadership 2015

Price Level 5 AD AS #1. Assume there is an increase in consumer spending. What happens to PL and output in the short- run? GDP R LRAS QYQY AD 1 PL e PL 1 Q1Q1 PL and Q will Increase Copyright ACDC Leadership 2015

Practice 6 AD or ASShifter Increase or Decrease Copyright ACDC Leadership 2015

Practice 1.An increase in consumer spending 2.The impact on net exports when a trading partner has a recession 3.A significant increase in the price of oil that affects the resource costs of businesses 4.Government increases spending but not taxes 5.Increase in wages that businesses pay workers 6.Effect on businesses when they expect inflation 7.Effect on investment when interest rates decrease 8.An increase in productivity 9.The impact on next exports when the country’s currency depreciates 10. Government increases corporate taxes 7

Practice 8 AD or ASShifterIncrease or Decrease 1ADCIncrease 2ADXDecrease 3ASRDecrease 4ADGIncrease 5ASRDecrease 6ASRDecrease 7ADIIncrease 8ASPIncrease 9ADXIncrease 10ASADecrease Copyright ACDC Leadership 2015

Inflationary and Recessionary Gaps 9 Copyright ACDC Leadership 2015

Capital Goods Consumer Goods The economy can only be in one of three places at any time 10 Full Employment 5% Unemployment Copyright ACDC Leadership 2015 Max Capacity 0% Unemployment Time Real GDP Real GDP Recessionary Gap Full Employment Inflationary Gap

Price Level 11 AD AS Example: Assume the government increases spending. What happens to PL and Output? GDP R LRAS QYQY AD 1 PL e PL 1 Q1Q1 PL and Q will Increase Copyright ACDC Leadership 2015

Price Level 12 AS Inflationary Gap GDP R LRAS QYQY AD 1 PL 1 Q1Q1 Output is high and unemployment is less than NRU Actual GDP above potential GDP Copyright ACDC Leadership 2015

Price Level 13 AD AS GDP R QYQY PL e PL 1 Q1Q1 LRAS AD 1 Example: Assume consumer spending falls. What happens to PL and Output? PL and Q will decrease Copyright ACDC Leadership 2015

Price Level 14 AS GDP R QYQY PL 1 Q1Q1 LRAS AD 1 Actual GDP below potential GDP Recessionary Gap Output low and unemployment is more than NRU Copyright ACDC Leadership 2015

Price Level 15 AD AS GDP R QYQY PL e PL 1 Q1Q1 LRAS AS 1 Stagflation Stagnate Economy + Inflation Example: If there is a negative “supply shock” of oil. What happens to PL and Output? Still considered recessionary gap Copyright ACDC Leadership 2015

2008 Audit Exam

2012 Exam

AD and AS Practice Worksheet 21 Copyright ACDC Leadership 2015

What Happens In the Long-Run? 22 Copyright ACDC Leadership 2015

23 AD AS If consumer spending increases, what will happen in the short-run and in the long-run? GDP R QYQY AD 1 PL e PL 1 Q1Q1 LRAS In the long-run, wages and costs increase AS 1 PL 2 Time Real GDP Price Level Real GDP Copyright ACDC Leadership 2015

24 If consumer spending increases, what will happen in the short-run and in the long-run? GDP R QYQY AD 1 LRAS In the long-run, wages and costs increase AS 1 PL e Time Real GDP Price Level Real GDP Copyright ACDC Leadership 2015

25 AD AS If consumer spending decreases, what will happen in the short-run and in the long-run? GDP R QYQY AD 2 PL e PL 1 Q1Q1 LRAS In the long-run, wages & costs eventually decrease AS 2 PL 2 Time Real GDP Price Level Real GDP Copyright ACDC Leadership 2015

Practice 26 Copyright ACDC Leadership 2015

Price Level 27 AD AS #1. Assume there is an increase in government spending. What happens to PL and output in the short- run? GDP R LRAS QYQY AD 1 PL e PL 1 Q1Q1 PL and Q will Increase Copyright ACDC Leadership 2015

Price Level 28 AD AS #2. Consumer expectations fall and consumer spending plummets. What happens to price level and output in the long-run? GDP R LRAS QYQY AD AD 1 PL 1 Q1Q1 AS 1 PL 2 PL e Price Level decreases and output stay s the same Copyright ACDC Leadership 2015

Price Level 29 AD AS #3. If consumer spending increases, what happens to price level and output in the long-run? GDP R QYQY AD 1 PL e PL 1 Q1Q1 LRAS AS 1 PL 2 Price level increases and output stays the same Copyright ACDC Leadership 2015

2008 Audit Exam

Economic Growth 31 Copyright ACDC Leadership 2015

32 AD AS If investment increases, what happens in the short-run and long-run? GDP R QYQY AD 1 PL e PL 1 Q1Q1 LRAS Capital Stock- Machinery and tools purchased by businesses that increase their output AS 1 Price Level Copyright ACDC Leadership 2015 Capital Goods Consumer Goods The PPC shifts outward since producers can make more LRAS 1 Q Y1

33 GDP R AD 1 PL e An increase in consumption or government spending doesn’t cause economic growth. Only Investment causes growth since firms increase their capital stock AS 1 Price Level Copyright ACDC Leadership 2015 Capital Goods Consumer Goods LRAS 1 Q Y1

2008 Audit Exam

FRQ #3

FRQ #3