An analysis of the use of AD and AS in macro equilibrium MACRO ECONOMIC EQUILIBRIUM 12.2A

LEARNING OBJECTIVES Define aggregate demand and aggregate supply Describe the components of aggregate demand/supply Analyse the difference effects of changes aggregate demand and aggregate supply

REVIEW What about market supply? So what do you remember about demand analysis?

REVIEW EXERCISE USE DEMAND AND SUPPLY ANALYSIS to clarify (explain) the general impact of a current event on equilibrium prices and quantities. CREATE your own event !

GROUP EXERCISE Event: The WSJ reports that the prices of PC components are expected to fall by 5-8 percent over the next six months. Scenario 1: You manage a small firm that manufactures PCs. Scenario 2: You manage a small software company. Perform a Demand/ Supply Analysis to show the effects of each of these on the market

Investigating AGGREGATE DEMAND and AGGREGATE SUPPLY THE MACRO ECONOMY

QUESTION? How does the macro economy equilibrium differ from the micro economy?

AD and AS AD - represents the demand side of the economy. AS – represents the supply side

…Some thoughts The AD/AS model represents all goods and not just one single good. It takes into account the price level of all goods aggregate output of the economy. GDP

Aggregate Demand

Definition Aggregate means ‘total’

AGGREGATE DEMAND Aggregate demand is the demand for the gross domestic product (GDP) of a country, and is represented by this formula: Aggregate Demand (AD) = C + I + G + (X-M)

COMPONENTS OF AD C + I + G + (X-M) C = Consumers' expenditures on goods and services. I = Investment spending by companies on capital goods. G = Government expenditures on publicly provided goods and services. X = Exports of goods and services. M = Imports of goods and services.

SLOPE OF THE AD CURVE There is a negative relationship between aggregate demand and the price level. : Aggregate demand rises as the price level falls.

EFFECT OF AGGREGATE DEMAND THE WEALTH EFFECT The International Effect: The Interest Rate Effect:

…so how does this effect aggregate demand? Interest? Wealth? International activity?

AD is the same in both the short run and the long run. Aggregate Demand represents how a change in a certain price level will change expenditures on all goods and services in an economy AD is the same in both the short run and the long run. Aggregate Demand represents how a change in a certain price level will change expenditures on all goods and services in an economy REMEMBER !!!

FACTORS THAT AFFECT AD

Aggregate Supply

DEFINITION AggregateAggregate (AS) supply supply measures the amount of goods and services produced within the economy at a given price level.

LRAS vs SRAS D ifferent or the same? What do you think?

What is the difference? WHYWHY

AS represents the ability of an economy to deliver goods and services to meet demand LONG RUN SHORT RUN < One year > One year

AGGREGATE SUPPLY (AS) The Long-Run Aggregate Supply (LAS) no input prices are assumed to be constant. Thus, LAS is a representation of potential output.

AGGREGATE SUPPLY It consists of: Long-run Aggregate Supply (LAS) represents the most output that an economy can sustain “(put up with)”. Short-run Aggregate Supply (SAS) represents the supply of the economy in the short run.

LONG RUN AS The LAS curve is vertical. It shows potential output. All prices, even input prices, rise when a rise in price level occurs.

LRAS Since the LAS is POSSIBLE output it is shifted by the factors which affect potential output FACTORS THAT AFFECT LRAS available resources capital entrepreneurship technological developments As these LRAS SHIFTS

AGGREGATE SUPPLY CURVES

SHORT RUN AGGREGATE SUPPLY ONLY two variables ( PRICE LEVEL and AGGREGATE REAL PRODUCTION ) change * Everything else remains constant CETERIS PARIBUS OPERATES (IN SR ONLY) SRAS is an UPWARD SLOPING CURVE

SHORT RUN AS Shifts of the short-run aggregate supply curve can be brought about by such things as:  technology,  changes in wages  changes in other resource prices  changes in resource quantities.

The 3 ranges of AGGREGATE SUPPLY

QUESTION 1) Does the level of aggregate supply remain the same in the short run? 2) Analyse the impact of inflation and unemployment on SRAS 3) Is it possible to lower unemployment by raising inflation?