1. Chapter 10
End of Chapter 10
ECON 151 – PRINCIPLES OF MACROECONOMICS
Chapter 10: Real GDP and the Price Level in the Long Run
Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved. 1

2. Output Growth and the Long-Run Aggregate Supply Curve
The total of all planned production for the economy

3. Output Growth and the Long-Run Aggregate Supply Curve (cont'd)
A vertical line representing the real output of goods and services after full adjustment has occurred
It represents the real GDP of the economy under conditions of full employment; the economy is near its production possibilities curve 8

4. Figure 10-1 The Production Possibilities and the Economy’s Long-Run Aggregate Supply Curve

5. Output Growth and the Long-Run Aggregate Supply Curve (cont'd)
LRAS is vertical
Input prices fully adjust to changes in output prices
Suppliers have no incentive to increase output
Unemployment is at the natural rate
Determined by endowments and technology (or existing resources) 10

6. Output Growth and the Long-Run Aggregate Supply Curve (cont'd)
Growth is shown by outward shifts of either the production possibilities curve or the LRAS curve caused by
Growth of population and the labor-force participation rate
Capital accumulation
Improvements in technology 11

7. Figure 10-2 The Long-Run Aggregate Supply Curve and Shifts in It

8. Figure 10-3 A Sample Long-Run Growth Path for Real GDP

9. Total Expenditures and Aggregate Demand
The total of all planned expenditures in the entire economy (planned may not equal actual)
Aggregate Demand Curve
A curve showing planned purchase rates for all final goods and services in the economy at various price levels, all other things held constant 14

10. Aggregate Demand versus Demand for a Single Good
When the aggregate demand curve is derived, we are looking at the entire circular flow of income and product.
When a demand curve is derived, we are looking at a single product in one market only.
Note the labels on the respective graphs are different. 26

11. Figure 10-4 The Aggregate Demand Curve
As the price level rises, real GDP declines

12. The Aggregate Demand Curve (cont'd)
What happens when the price level rises or falls?
The real-balance effect (or wealth effect)
The interest rate effect
The open economy effect 22

13. The Aggregate Demand Curve (cont'd)
The Real-Balance Effect
The change in the real value of money balances when the price level changes
The Interest Rate Effect
Higher price levels indirectly increase the interest rate, which in turn causes a reduction in borrowing and spending.
The Open Economy Effect
Higher price levels result in foreigners’ desiring to buy fewer American-made goods while Americans desire more foreign-made goods (i.e., net exports fall). 23

14. Movement Along the Aggregate Demand Curve
120
GDP Deflator 90 AD 1 2 3 4 5 6 7
Real GDP per Year ($ trillions)

15. Shifts in the Aggregate Demand Curve
Any non-price-level change that increases aggregate spending (on domestic goods) shifts AD to the right.
Any non-price-level change that decreases aggregate spending (on domestic goods) shifts AD to the left. 27

16. Table 10-1 Determinants of Aggregate Demand

17. Shifts in the Aggregate Demand Curve (cont'd)
Increase in aggregate demand
120
GDP Deflator 90
AD1 AD 1 2 3 4 5 6 7
Real GDP per Year ($ trillions)

18. Shifts in the Aggregate Demand Curve (cont'd)
Decrease in aggregate demand
120
GDP Deflator
100
AD1 AD 9 10 11 12 13 14 15
Real GDP per Year ($ trillions)

19. Long-Run Equilibrium and the Price Level
For the economy as a whole, long-run equilibrium occurs at the price level where the aggregate demand curve (AD) crosses the long-run aggregate supply curve (LRAS). 37

20. Figure 10-5 Long-Run Economywide Equilibrium

21. Long-Run Equilibrium and the Price Level (cont'd)
The effects of economic growth on the price level
Economic growth and secular deflation
Secular Deflation
A persistent decline in prices resulting from economic growth in the presence of stable aggregate demand

22. Secular Deflation versus Long-Run Price Stability in a Growing Economy
An increase in LRAS will, ceteris paribus, result in a decrease in the price level.
Avoiding secular deflation
If the AD curve shifts outward by the same amount as the LRAS curve, the price level remains constant.
The AD curve can be shifted outward by increasing the money supply. 41

23. Figure 10-6 Secular Deflation versus Long-Run Price Stability in a Growing Economy, Panel (a)

24. Figure 10-6 Secular Deflation versus Long-Run Price Stability in a Growing Economy, Panel (b)

25. Figure 10-7 Inflation Rates in the United States
Source: Economic Report of the President; Economic Indicators, various issues

26. Figure 10-8 Explaining Persistent Inflation, Panel (a)
• When LRAS1 shifts to LRAS2, the price level rises from 120 to 140
• Inflation is caused by a decrease in LRAS

27. Figure 10-8 Explaining Persistent Inflation, Panel (b)
An increase in AD from AD1 to AD2 causes the price level to rise from 120 to 140, and an increase in AD causes inflation

28. Figure 10-9 Real GDP and the Price Level in the United States, 1970 to the Present

29. End of Chapter 10
ECON 151 – PRINCIPLES OF MACROECONOMICS
Chapter 10: Real GDP and the Price Level in the Long Run
Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.