1. NATIONAL INCOME AND PRICE DETERMINATION

2. 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 = I + R + A + P Change in R esource Prices Change in A ctions of the Government Change in P roductivity (Investment) 2 Change in I nflationary Expectations

3. B A D A D B A A C A major increase in productivity. A Answer and identify shifter: C.I.G.X or I.R.A.P 3

4. Putting AD and AS together to get Equilibrium Price Level and Output 4

5. How does this cartoon relate to Aggregate Demand? 5

6. Macroeconomic equilibrium occurs at the intersection of aggregate demand and short-run aggregate supply. **Handout It can also happen that this occurs at the long-run equilibrium point, but not necessarily. Aggregate Price Level Aggregate Output LRAS SRAS AD

9. As we have learned a Demand Shock can effect equilibrium: (demand shocks are shifts in the AD curve and Supply shocks are shifts in the SRAS)

10. Shocks Demand shock causes Ag. Price Level and Ag. Output to move in the same direction Supply Shock causes them to move in opposite directions

11. Shocks cont. Demand shocks have short-run effects on Ag. Output because the economy is self-correcting in the long run In a recessionary gap, an eventual fall in nominal wages moves the economy to long- run equilibrium (wages are sticky—slow to move-- in the SR) In an inflationary gap, an eventual rise in nominal wages moves the economy to long run equilibrium

12. To sum it up… Shocks cause a shift in the Aggregate Demand or Supply and can also lead to Recessionary Gaps or Inflationary Gaps or Stagflation Stagflation is inflation and falling output and is caused by a negative supply shock

13. What’s it look like?

14. Price Level 14 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

15. Price Level 15 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

16. Price Level 16 AD GDP R QYQY PL 1 Q1Q1 LRAS AS 1 Recessionary Gap Output low and unemployment is more than NRU Actual GDP below potential GDP

17. Price Level 17 AD AS GDP R QYQY PL e PL 1 Q1Q1 LRAS AS 1 Stagflation Stagnate Economy + Inflation Example: Assume the price of oil increases drastically. What happens to PL and Output?

18. What about the long run? Baby Steps

19. Price Level 19 AD AS 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

20. Price Level 20 AD AS Now, what will happen in the LONG RUN? GDP R QYQY AD 1 PL e PL 1 Q1Q1 LRAS Inflation means workers seek higher wages and production costs increase AS 1 PL 2 Back to full employment with higher price level

21. Price Level 21 AD AS Assume consumers increase spending. What happens to PL and Output? GDP R LRAS QYQY AD 1 PL e PL 1 Q1Q1

22. Price Level 22 AD AS Now, what will happen in the LONG RUN? GDP R QYQY AD 1 PL e PL 1 Q1Q1 LRAS Inflation means workers seek higher wages and production costs increase AS 1 PL 2 Back to full employment with higher price level

23. Supply shocks and demand shocks can cause recessions

24. Long Term Equilibrium To summarize how an economy responds to recessions/inflation we focus on Output Gap which is the % difference between actual aggregate output and potential output. Actual Aggregate Output-Potential Output x 100 Potential Output In the Long Run the economy is self-correcting but many times Governments are not willing to wait that long which brings about Macroeconomic Policy