UNIT 3- Aggregate Supply and Demand

AD Basics AD = C + I + G +Xn What causes a movement along the curve? What causes a shift in the curve?

Downward Sloping Interest Rate Effect – Price of Borrowing for Capital/Durable Good Purchases – Increasing PLIncreasing Interest Rates Wealth Effect – Increase PLDecrease Purchasing Power (real wealth) Net Exports Effect – Increase in PL Decrease X (exports) Increase M (imports)

Investment Demand

The Multiplier- Background Disposable Income= Income – Taxes DI = Consumption + Savings Average Propensity to Consume = C/DI Average Propensity to Save = S/DI APC + APS = 1

It’s All About the Marginal Baby MPC = C / DI – In other words, the portion of an additional dollar of DI spent on consumption MPS = S / DI – In other words, the portion of an additional dollar of DI spent on consumption MPC + MPS = 1

Spending Multiplier Savings is a leakage Savings includes “investment” (stocks and stuff) 1/MPS Given a MPC of.6, what is the spending multiplier? If East Penn School District buys every student a laptop at a cost of 1.9 million, what is the resulting change in GDP?

Tax Multiplier It’s NEGATIVE -MPC/MPS Less than Spending Multiplier Given MPS =.1, what is the tax multiplier?

Multiplier Mania 1.Spending Multiplier = 1/.15 = X $140 Billion = $933 Billion 2.Spending Multiplier = 1/.25 = 4 4 X Gov’t Spending = $800 Billion $800 Billion/4 = $200 Billion

Multiplier Mania 3. Tax Multiplier = -.75/.25 = X Tax Cut = $800 Billion $800 Billion/-3 = $ Billion

Multiplier Mania 4. a. 1/.15 X $350 Billion = Spending Increase 6.67 X $350 Billion = $2,334.5 Billion b. $2,334.5 B - $1,500 B = $834.5 B Tax Mult = -.85/.15 = X Tax Increase = -$834.5 B $834.5 B/-5.67 = $147 Billion tax increase

Aggregate Supply Draw it! What are the only 2 determinants?

Multipliers Spending= 1/MPS Tax = -MPC/MPS

Aggregate Supply

Shifts -Price of Inputs -Productivity Movements -Change in PL

Inflation Types

SRAS- Why is it upward sloping? Sticky Prices and Sticky Wages – Contracts in the short run – Sticky prices- incentive to work more/menu costs – Sticky wages- incentive to hire more/MRC=MRP Real Wage Misperception – Thinking nominal wage increase is a real wage increase

Aggregate Supply

Agenda Some New Terms Adjustments to LRE Graded Practice w/o LR- 15 minutes at least!

Shocks Demand Shock- change in price level and output resulting from change (JB) in AD Supply Shock- guess

Long Run Equilibrium (Full Employment)

Recessionary Gap

Expansionary/Inflationary Gap

Agenda LRAS Shifts Applying Unemployment Data

How might this help to explain Murphs concern about declining real wages?

LRAS Shifts SRAS Shifts with LRAS Determinants – Resource Quantity Population Growth/Labor Force Participation Rate Capital Investment*/Capital Stock Exploration – Resource Quality Technology (including production techniques) Education/Training

Unemployment Data Draw a AD AS graph. – Show SRE in relation to LRAS – Label the Gap – Identify the un(or excess) employment represented by the gap Draw the Business Cycle – Label it – Write today’s date with an arrow to our current position

The data in the table above suggest that in year 2 a) aggregate demand increases. b) aggregate supply decreases. c) aggregate supply increases. d) aggregate supply remains constant. e) aggregate demand decreases.