Chapter 12, Aggregate Demand and Aggregate Supply
Foreign Purchases Effect (as price level rises)
A higher price level decreases net export spending...which decreases spending on U.S. exports and increases spending on U.S. imports ...which decreases real GDP
Interest-rate Effect (as price level rises)
A higher price level increases the nominal interest rate...which decreases consumer spending on interest-sensitive products (e.g., autos) and also business investment...which decreases real GDP
Aggregate Demand (AD)
shows the amount of goods and services which will be purchased at each possible price level
Assume the prices are fully flexible in an economy. If aggregate demand increased and aggregate supply decreased, what will happen to the price level and real output?
the affect on the real output will be uncertain but the price level will increase, An increase in aggregate demand and an increase in aggregate supply are certain to increase the price level, but the effect on real GDP will be uncertain based on the size of the shifts in AD and AS.
AggregateSupply in the Immediate Short Run
The aggregate supply curve is horizontal at a given price level due to the rigidity of prices
would most likely lead to an increase in aggregate demand?
The government passes legislation that sharply increases spending for national defense and roads, an increase in government spending increases AD
would most likely increase aggregate demand?
a depreciation in the value of the U.S. dollar, A depreciation of the U.S. dollar means that U.S. exports are less expensive for foreigner to buy and that U.S. imports are now more expensive. Net export therefore will increase and increase aggregate demand.
A decline in the amount of government regulation is most likely to
increase aggregate supply, A decline in government regulation reduces the cost of production and thus increases
In the context of aggregate supply, the basic difference between the immediate short run and the short run is that in the immediate short run
input prices and output prices are fixed, while in the short run input prices are fixed but output prices are flexible, in the immediate short run, both input prices as well as output prices are fixed. In the short run, input prices are fixed but output prices can vary.
The aggregate demand curve slopes downward due to the
inverse relationship between the price level and real GDP
Aggregate supply
is a schedule or curve showing the level of real domestic output available at each possible price level.
is a major reason why prices and wages tend to be inflexible downward
menu costs, Businesses do not like to lower prices because it can reduce profits, be costly due to menu costs, and lead to price wars. Businesses also do not like to reduce wages because it hurts work morale and work effort
Assume that it takes 100 units of input to produce 300 units of output in an economy. Then because of an improvement in technology, it requires only 75 units of input to produce the same level of output
productivity in the economy increased from 3 to 4, Productivity is measured by dividing total output by total input. So productivity changes from 300/100 =3 to 300/75 = 4
If AD decreases
recession and cyclical unemployment may result
efficiency wages
wages that maximize work effort and productivity, minimizing cost.
The multiplier effect
weakens the further right the aggregate demand curve moves along the aggregate supply curve.More of the increase in spending is absorbed into price increases instead of generating greater real output.
Real-balances Effect (as price level rises)
A higher decreases the real value of financial assets ...which decreases household wealth and consumer spending ...which decreases real GDP
A rise in the interest rate for business loans
AD decreases, AS remains the same, Price level decreases, Quantity decreases
An increase in business taxes
AD decreases, AS remains the same, Price level decreases, Quantity decreases
Balancing the federal budget cuts government spending
AD decreases, AS remains the same, Price level decreases, Quantity decreases
An improvement in consumer and business confidence.
AD increases, AS remains the same, Price level increases, Quantity decreases
A rise in the national incomes of our trading partners
AD increases, AS remains the same, Price level increases, Quantity increases
Consumer income rise as the economy moves out of a recession
AD increases, AS remains the same, Price level increases, Quantity increases
There is a depreciation in the value of the United States Dollar
AD increases, AS remains the same, Price level increases, Quantity increases
The price of oil on the world market rises to a high level
AD remains the same, AS decreases, Price level increases, Quantity decreases
A rise in the price of imported chemicals
AD remains the same, AS decreases, Price level remains the same, Quantity decreases
An increase in labor productivity
AD remains the same, AS increases, Price level decreases, Quantity increases
Changes in Aggregate Demand
Consumer wealth Household borrowing Consumer expectations Personal taxes Real interest rates Expected returns, which are a function of: Expected future business conditions Technology Degree of excess capacity Business taxes
Aggregate Demand Decrease results
Price level decrease and Quantity decrease.
Aggregate Supply Increase results
Price level decrease and Quantity increase
Aggregate Demand decrease and Aggregate Supply Increase results
Price level decrease and Quantity is uncertain
Aggregate Supply Decrease results
Price level increase and Quantity decrease
Aggregate Demand Increase results
Price level increase and Quantity increase.
Aggregate Demand Increase and Aggregate Supply Decrease results
Price level increase and Quantity is uncertain
Aggregate Demand Decrease and Aggregate Supply Decrease results
Price level is uncertain and Quantity decrease
Aggregate Demand Increase and Aggregate Supply Increase results
Price level is uncertain and Quantity increase
Aggregate Supply in the Short Run
The short run aggregate supply curve is upward sloping.
Cost-push inflation occurs because
aggregate supply decreases, Cost-push inflation occurs because of a decrease in aggregate supply that "pushes" up the price level
change would be associated most closely with an increase in economic growth in an economy
an increase in aggregate supply, An increase in aggregate supply will increase real output that is associated with economic growth
most likely increase aggregate demand?
an increase in consumer wealth, increase in consumer spending is known as the wealth effect and shifts the AD curve to the right
most likely decrease aggregate demand?
an increase in real interest rates, Rising real interest rates makes it more expensive to borrow money and this will decrease investment spending
Increases in aggregate demand
cause demand-pull inflation
Aggregate supply in the Long Run
curve is vertical at the economy's full-employment output. The curve is vertical because in the long-run resources prices adjust to changes in the price level, leaving no incentive for firms to change their output.
A decrease in aggregate demand in the short-run when the price level is flexible will
decrease real output and decrease the price level, With flexible prices, a decrease in aggregate demand will reduce the price level and real output
If aggregate demand increases, this situation is most likely to lead to
demand-pull inflation