AD - AS

Aggregate Demand Curve 29-2 Real Domestic Output, GDP Price Level AD Aggregate Demand

29-3 Aggregate Demand Amount of real GDP purchased at each price level AD = C + I + G + X n Why the downward slope? No income or substitution effect like regular demand Wealth (real balances) effect: purchasing power of held assets (C) Interest-rate effect: demand for $ (I) Foreign purchases effect (X) Consumption, investment, and net exports

4 Shifters of Aggregate Demand GDP = C + I + G + X n Copyright ACDC Leadership 2015

29-5 Changes in Aggregate Demand Real Domestic Output, GDP Price Level AD 1 Increase in Aggregate Demand AD 3 AD 2 Decrease in Aggregate Demand **Notice the multiplier effect

Shifters of Aggregate Demand 1.Change in Consumer Spending Increase in Disposable Income or Wealth (Higher incomes/Value of assets) Consumer Expectations (People fear a recession…) Household Indebtedness (More consumer debt…) Taxes (Decrease in income taxes…) 2. Change in Investment Spending Real Interest Rates (r = i) - Price of borrowing $ - related to money supply (If interest rates increase…) (If interest rates decrease…) Future Business Expectations (High expectations…) Productivity and Technology (New robots…) Business Taxes (Higher corporate taxes means…) 6

Shifters of Aggregate Demand 3.Change in Government Spending Government Expenditures - *non-transfers only (Decrease in defense spending…) (Increase in public works programs…) 7 4.Change in Net Exports (X-M) Exchange Rates (If the us dollar depreciates relative to the euro…) National Income Compared to Abroad (If a major importer has a recession…) (If the US has a recession…) AD = GDP = C + I + G + X n Copyright ACDC Leadership 2015

29-8 Amount real GDP produced at each price level Three time horizons: 1. Immediate short run Few days to a few months Sticky prices and wages All prices fixed (input and output) Implicit price agreements (output) Contractual agreements (input) Aggregate Supply - Stages

29-9 Aggregate Supply – Immediate Short Run Real Domestic Output, GDP Price Level AS ISR Immediate-short- run Aggregate Supply QfQf

Immediate Short Run 29-10

Short run Input prices fixed, Output prices variable In the Short Run, do firms prefer increase or decrease in Price Level? Increase! – Fixed input contracts Real profit changes Aggregate Supply - Stages

29-12 Real Domestic Output, GDP Price Level 0 QfQf Aggregate Supply (Short Run) Slope not constant: per unit production cost and firm capacity Aggregate Supply – Short Run Competition for resources hikes ATC Plentiful resources limit growth of ATC

Aggregate Supply - Stages 3. Long run All prices variable – inputs and outputs Full employment GDP All prices adjust

29-14 Aggregate Supply – Long Run Real Domestic Output, GDP Price Level AS LR Long-run Aggregate Supply QfQf **In the long run, the economy will produce at the full employment output.

Change in input price (land, labor, capital) Domestic resource prices Prices of imported resources Supply shocks 2. Change in productivity/technology 3. Change in legal-institutional environment Business taxes and subsidies Government regulation Determinants of Aggregate Supply:

Determinants of Aggregate Supply RPG R Resource Prices P Productivity G Government taxes, subsidies, regulation ***Government ACTION - not government spending 29-16

29-17 Real Domestic Output, GDP Price Level AS 1 Increase in Aggregate Supply AS 3 AS 2 Decrease in Aggregate Supply Aggregate Supply

Price Level 18 AD AS GDP R QYQY PL e LRAS Use the AD and AS model to show an economy at full employment output Copyright ACDC Leadership 2015

Price Level 19 AD AS #1. Assume there is an increase in consumer spending. What happens to PL and output in the short-run? GDP R LRAS QYQY AD 1 PL e PL 1 Q1Q1 PL and Q will Increase Copyright ACDC Leadership 2015

Practice 20 AD or ASShifter Increase or Decrease Copyright ACDC Leadership 2015

Practice 1. An increase in consumer spending 2. The impact on net exports when a trading partner has a recession 3. A significant increase in the price of oil that affects the resource costs of businesses 4. Government increases spending but not taxes 5. Increase in wages that businesses pay workers 6. Effect on businesses when they expect inflation 7. Effect on investment when interest rates decrease 8. An increase in productivity 9. The impact on next exports when the country’s currency depreciates 10. Government increases corporate taxes 21

Practice 22 AD or ASShifterIncrease or Decrease 1ADCIncrease 2ADXDecrease 3ASRDecrease 4ADGIncrease 5ASRDecrease 6ASRDecrease 7ADIIncrease 8ASPIncrease 9ADXIncrease 10ASADecrease Copyright ACDC Leadership 2015

Inflationary and Recessionary Gaps 23 Copyright ACDC Leadership 2015

Capital Goods Consumer Goods The economy can only be in one of three places at any time 24 Full Employment 5% Unemployment Copyright ACDC Leadership 2015 Max Capacity 0% Unemployment Time Real GDP Real GDP Recessionary Gap Full Employment Inflationary Gap

Price Level 25 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 Copyright ACDC Leadership 2015

Price Level 26 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 Copyright ACDC Leadership 2015

Price Level 27 AD AS GDP R QYQY PL e PL 1 Q1Q1 LRAS AD 1 Example: Assume consumer spending falls. What happens to PL and Output? PL and Q will decrease Copyright ACDC Leadership 2015

Price Level 28 AS GDP R QYQY PL 1 Q1Q1 LRAS AD 1 Actual GDP below potential GDP Recessionary Gap Output low and unemployment is more than NRU Copyright ACDC Leadership 2015

Price Level 29 AD AS GDP R QYQY PL e PL 1 Q1Q1 LRAS AS 1 Stagflation Stagnate Economy + Inflation Example: If there is a negative “supply shock” of oil. What happens to PL and Output? Still considered recessionary gap Copyright ACDC Leadership 2015

2008 Audit Exam

2012 Exam

AD and AS Practice Worksheet 35 Copyright ACDC Leadership 2015

What Happens In the Long-Run? 36 Copyright ACDC Leadership 2015

37 AD AS If consumer spending increases, what will happen in the short-run and in the long-run? GDP R QYQY AD 1 PL e PL 1 Q1Q1 LRAS In the long-run, wages and costs increase AS 1 PL 2 Time Real GDP Price Level Real GDP Copyright ACDC Leadership 2015

38 If consumer spending increases, what will happen in the short-run and in the long-run? GDP R QYQY AD 1 LRAS In the long-run, wages and costs increase AS 1 PL e Time Real GDP Price Level Real GDP Copyright ACDC Leadership 2015

39 AD AS If consumer spending decreases, what will happen in the short-run and in the long-run? GDP R QYQY AD 2 PL e PL 1 Q1Q1 LRAS In the long-run, wages & costs eventually decrease AS 2 PL 2 Time Real GDP Price Level Real GDP Copyright ACDC Leadership 2015

Practice 40 Copyright ACDC Leadership 2015

Price Level 41 AD AS #1. Assume there is an increase in government spending. What happens to PL and output in the short- run? GDP R LRAS QYQY AD 1 PL e PL 1 Q1Q1 PL and Q will Increase Copyright ACDC Leadership 2015

Price Level 42 AD AS #2. Consumer expectations fall and consumer spending plummets. What happens to price level and output in the long-run? GDP R LRAS QYQY AD AD 1 PL 1 Q1Q1 AS 1 PL 2 PL e Price Level decreases and output stay s the same Copyright ACDC Leadership 2015

Price Level 43 AD AS #3. If consumer spending increases, what happens to price level and output in the long-run? GDP R QYQY AD 1 PL e PL 1 Q1Q1 LRAS AS 1 PL 2 Price level increases and output stays the same Copyright ACDC Leadership 2015

2008 Audit Exam

Economic Growth 45 Copyright ACDC Leadership 2015

46 AD AS If investment increases, what happens in the short-run and long-run? GDP R QYQY AD 1 PL e PL 1 Q1Q1 LRAS Capital Stock- Machinery and tools purchased by businesses that increase their output AS 1 Price Level Copyright ACDC Leadership 2015 Capital Goods Consumer Goods The PPC shifts outward since producers can make more LRAS 1 Q Y1

47 GDP R AD 1 PL e An increase in consumption or government spending doesn’t cause economic growth. Only Investment causes growth since firms increase their capital stock AS 1 Price Level Copyright ACDC Leadership 2015 Capital Goods Consumer Goods LRAS 1 Q Y1

2008 Audit Exam

FRQ #3

FRQ #3