Macro 10

Changes in Aggregate Demand

A change in any influence on buying plans other than the price level changes aggregate demand. The main influences on aggregate demand are Expectations Fiscal policy and monetary policy The world economy

Wealth Effect

A rise in the price level, other things remaining the same, decreases the quantity of real wealth (money, stocks, etc.). To restore their real wealth, people increase saving and decrease spending. The quantity of real GDP demanded decreases. Similarly, a fall in the price level, other things remaining the same, increases the quantity of real wealth, which increases the quantity of real GDP demanded.

The Aggregate Demand Curve

Aggregate demand is the relationship between the quantity of real GDP demanded and the price level. The aggregate demand curve (AD) plots the quantity of real GDP demanded against the price level.

Changes in Aggregate Supply

Aggregate supply changes if an influence on production plans other than the price level changes. These influences include Changes in potential GDP Changes in money wage rate (and other factor prices)

the quantity of real GDP supplied is potential GDP.

As the price level rises and the money wage rate changes by the same percentage, the quantity of real GDP supplied remains at potential GDP.

A classical macroeconomist

believes that the economy is self-regulating and always at full employment. The term "classical" derives from the name of the founding school of economics that includes Adam Smith, David Ricardo, and John Stuart Mill.

Monetary Policy

Because government expenditure on goods and services is one component of aggregate demand, an increase in government expenditure increases aggregate demand. The Fed's attempt to influence the economy by changing the interest rate and adjusting the quantity of money is called monetary policy. An increase in the quantity of money increases buying power and increases aggregate demand. A cut in interest rates increases expenditure and increases aggregate demand.

economic growth curve

Because the quantity of labor grows, capital is accumulated, and technology advances, potential GDP increases. The LAS curve shifts rightward.

Substitution Effects

Intertemporal substitution effect: A rise in the price level, other things remaining the same, decreases the real value of money and raises the interest rate. When the interest rate rises, people borrow and spend less, so the quantity of real GDP demanded decreases. Similarly, a fall in the price level increases the real value of money and lowers the interest rate. When the interest rate falls, people borrow and spend more, so the quantity of real GDP demanded increases.

Expectation

Expectations about future income, future inflation, and future profits change aggregate demand. Increases in expected future income increase people's consumption today and increases aggregate demand. A rise in the expected inflation rate makes buying goods cheaper today and increases aggregate demand. An increase in expected future profits boosts firms' investment, which increases aggregate demand.

Fiscal Policy

Fiscal policy is the government's attempt to influence the economy by setting and changing taxes, making transfer payments, and purchasing goods and services. A tax cut or an increase in transfer payments increases households' disposable income—aggregate income minus taxes plus transfer payments. An increase in disposable income increases consumption expenditure and increases aggregate demand.

a short-run equilibrium curve

If real GDP is below equilibrium GDP, firms increase production and raise prices... ... and if real GDP is above equilibrium GDP, firms decrease production and lower prices.

inflation curve

If the quantity of money grows faster than potential GDP, aggregate demand increases by more than long-run aggregate supply. The AD curve shifts rightward faster than the rightward shift of the LAS curve.

long run curve

In the long run, the money wage rate rises until the SAS curve passes through the long-run equilibrium point.

the adjustment to long-run equilibrium

Initially, the economy is at below-full employment equilibrium. In the long run, the money wage falls until the SAS curve passes through the long-run equilibrium point.

Long-Run Aggregate Supply

Long-run aggregate supply is the relationship between the quantity of real GDP supplied and the price level when real GDP equals potential GDP. Potential GDP is independent of the price level. So the long-run aggregate supply curve (LAS) is vertical at potential GDP.

the effect of a rise in the money wage rate.

Short-run aggregate supply decreases and the SAS curve shifts leftward. Long-run aggregate supply does not change

Short-Run Aggregate Supply

Short-run aggregate supply is the relationship between the quantity of real GDP supplied and the price level when the money wage rate, the prices of other resources, and potential GDP remain constant. A rise in the price level with no change in the money wage rate and other factor prices increases the quantity of real GDP supplied. The short-run aggregate supply curve (SAS) is upward sloping.

effect of an increase in potential GDP.

The LAS curve shifts rightward and the SAS curve shifts along with the LAS curve.

inflationary gap

The amount by which potential GDP exceeds real GDP exceeds real GDP

recessionary gap

The amount by which real GDP is less than potential GDP less than real GDP

The Business Cycle in the AS-AD Model

The business cycle occurs because aggregate demand and the short-run aggregate supply fluctuate, but the money wage does not change rapidly enough to keep real GDP at potential GDP. An above full-employment equilibrium is an equilibrium in which real GDP exceeds potential GDP. A full-employment equilibrium is an equilibrium in which real GDP equals potential GDP. A below full-employment equilibrium is an equilibrium in which potential GDP exceeds real GDP.

Buying plans depend on many factors and some of the main ones are

The price level Expectations Fiscal policy and monetary policy The world economy

Y = C + I + G + X - M.

The quantity of real GDP demanded, Y, is the total amount of final goods and services produced in the United States that people, businesses, governments, and foreigners plan to buy. This quantity is the sum of consumption expenditures, C, investment, I, government expenditure, G, and net exports, X - M. That is,

Quantity Supplied and Supply

The quantity of real GDP supplied is the total quantity that firms plan to produce during a given period. Aggregate supply is the relationship between the quantity of real GDP supplied and the price level. We distinguish two time frames associated with different states of the labor market: Long-run aggregate supply Short-run aggregate supply

The AD curve slopes downward for two reasons:

Wealth effect Substitution effects

changes in aggregate demand on curve

When aggregate demand increases, the AD curve shifts rightward... ... and when aggregate demand decreases, the AD curve shifts leftward.

Changes in Potential GDP

When potential GDP increases, both the LAS and SAS curves shift rightward. Potential GDP changes for three reasons: An increase in the full-employment quantity of labor An increase in the quantity of capital (physical or human) An advance in technology

Keynesian macroeconomist

believes that left alone, the economy would rarely operate at full employment and that to achieve and maintain full employment, active help from fiscal policy and monetary policy is required. The term "Keynesian" derives from the name of one of the twentieth century's most famous economists, John Maynard Keynes.

In the short run, the quantity of real GDP supplied

increases if the price level rises. The SAS curve slopes upward. A rise in the price level with no change in the money wage rate induces firms to increase production.

The World Economy

influences aggregate demand in two ways: A fall in the foreign exchange rate lowers the price of domestic goods and services relative to foreign goods and services, which increases exports, decreases imports, and increases aggregate demand. An increase in foreign income increases the demand for U.S. exports and increases aggregate demand.

monetarist

is a macroeconomist who believes that the economy is self-regulating and that it will normally operate at full employment, provided that monetary policy is not erratic and that the pace of money growth is kept steady. The term "monetarist" was coined by an outstanding twentieth-century economist, Karl Brunner, to describe his own views and those of Milton Friedman.

A new classical view

is that business cycle fluctuations are the efficient responses of a well-functioning market economy that is bombarded by shocks that arise from the uneven pace of technological change.

Long-Run Macroeconomic Equilibrium

occurs when real GDP equals potential GDP—when the economy is on its LAS curve. Long-run equilibrium occurs at the intersection of the AD and LAS curves.

Short-run macroeconomic equilibrium

occurs when the quantity of real GDP demanded equals the quantity of real GDP supplied at the point of intersection of the AD curve and the SAS curve.

new Keynesian

view holds that not only is the money wage rate sticky but also are the prices of goods.