Unit 6: Aggregate Demand and Supply and Fiscal Policy 1

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

Practice 3

A. Increase AD B. Decrease AD C. Increase AS D. Decrease AS E. No Change 1.Congress cuts taxes. 2.Labor productivity increases dramatically. 3.Autonomous investment spending decreased. 4.President cuts defense spending by 20 percent; no increase in domestic spending. 5.Survey shows consumer confidence jumps. 6.Low birth rate will decrease the labor force in future. 7.Stock market collapses; investors lose billions. 8.Unions grow more aggressive; wage rates increase. 9.OPEC successfully increases oil prices. 10.Giant natural gas discovery decreases energy prices. 11.Government spending to increase next fiscal year; president promises no increase in taxes. 12.Research shows that improved schools have increased the skills of American workers and managers.

A. Increase AD B. Decrease AD C. Increase AS D. Decrease AS E. No Change 1.Congress cuts taxes. A 2.Labor productivity increases dramatically. C 3.Autonomous investment spending decreased. B 4.President cuts defense spending by 20 percent; no increase in domestic spending. B 5.Survey shows consumer confidence jumps. A 6.Low birth rate will decrease the labor force in future. E 7.Stock market collapses; investors lose billions. B 8.Unions grow more aggressive; wage rates increase. D 9.OPEC successfully increases oil prices. D 10.Giant natural gas discovery decreases energy prices. C 11.Government spending to increase next fiscal year; president promises no increase in taxes. A 12.Research shows that improved schools have increased the skills of American workers and managers. C

Putting AD and AS together to get Equilibrium Price Level and Output 6

Inflationary and Recessionary Gaps 7

Price Level 8 AD AS Example: Assume the government increases spending. What happens to PL and Output? GDP R LRAS Q FE AD 1 PL e PL 1 Q1Q1 PL and Q will Increase

Price Level 9 AS Inflationary Gap GDP R LRAS Q FE AD 1 PL 1 Q1Q1 Output is high and unemployment is less than NRU Actual GDP above potential GDP

Price Level 10 AD AS GDP R Q FE 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?

Price Level 11 AD GDP R Q FE PL 1 Q1Q1 LRAS AS 1 Recessionary Gap Output low and unemployment is more than NRU Actual GDP below potential GDP

AD and AS Practice Worksheet 12

How does this cartoon relate to Aggregate Demand? 13

Price Level GDP R AS AD=C+I+G+X P2P2 P1P1 AD 2 Q f (Y*or FE) LRAS Q2Q2 Draw AD and AS at full employment Output IncreasesPL Increases 14

Short Run and Long Run 15

Price Level 16 AD AS Shifts in AD or AS change the price level and output in the short run GDP R Q FE PL e LRAS

Price Level 17 AD AS Example: Assume consumers increase spending. What happens to PL and Output? GDP R LRAS Q FE AD 1 PL e PL 1 Q1Q1

Price Level 18 AD AS Now, what will happen in the LONG RUN? GDP R Q FE 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

Price Level 19 AD AS Example: Consumer expectations fall and consumer spending plummets. What happens to PL and Output in the Short Run and Long Run? GDP R LRAS Q FE AD AD 1 PL 1 Q1Q1 AS 1 PL 2 PL e AS increases as workers accept lower wages and production costs fall