Unit 3: Aggregate Demand and Supply and Fiscal Policy 1 Copyright ACDC Leadership 2015

Shifters of Aggregate Demand Shifters of Aggregate Supply AD = C + I + G + X Change in Consumer Spending Change in Investment Spending Change in Government Spending Net EXport Spending Shifters of Aggregate Supply AS = R + A + P Change in Resource Prices Change in Actions of the Government Change in Productivity Copyright ACDC Leadership 2015

Putting AD and AS together to get Equilibrium Price Level and Output Copyright ACDC Leadership 2015

Use the AD and AS model to show an economy at full employment output LRAS Price Level AS PLe AD QY GDPR 4 Copyright ACDC Leadership 2015

#1. Assume there is an increase in consumer spending #1. Assume there is an increase in consumer spending. What happens to PL and output in the short- run? LRAS Price Level AS PL and Q will Increase PL1 PLe AD1 AD QY Q1 GDPR 5 Copyright ACDC Leadership 2015

Practice AD or AS Shifter Increase or Decrease 1 2 3 4 5 6 7 8 9 10 Copyright ACDC Leadership 2015

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

Practice AD or AS Shifter Increase or Decrease 1 AD C Increase 2 X 3 AS R 4 G 5 6 7 I 8 P 9 10 A Copyright ACDC Leadership 2015

Inflationary and Recessionary Gaps 9 Copyright ACDC Leadership 2015

The economy can only be in one of three places at any time Max Capacity 0% Unemployment Real GDP Capital Goods Real GDP Consumer Goods Time Recessionary Gap Full Employment 5% Unemployment Full Employment Inflationary Gap 10 Copyright ACDC Leadership 2015

Example: Assume the government increases spending Example: Assume the government increases spending. What happens to PL and Output? LRAS Price Level AS PL and Q will Increase PL1 PLe AD1 AD QY Q1 GDPR 11 Copyright ACDC Leadership 2015

Inflationary Gap Output is high and unemployment is less than NRU LRAS Price Level AS Actual GDP above potential GDP PL1 AD1 QY Q1 GDPR 12 Copyright ACDC Leadership 2015

Example: Assume consumer spending falls. What happens to PL and Output? LRAS Price Level AS PL and Q will decrease PLe PL1 AD AD1 Q1 QY GDPR 13 Copyright ACDC Leadership 2015

Recessionary Gap Output low and unemployment is more than NRU LRAS Price Level AS Actual GDP below potential GDP PL1 AD1 Q1 QY GDPR 14 Copyright ACDC Leadership 2015

Stagnate Economy + Inflation Still considered recessionary gap Example: If there is a negative “supply shock” of oil. What happens to PL and Output? LRAS Price Level AS1 AS Stagflation Stagnate Economy + Inflation PL1 PLe Still considered recessionary gap AD Q1 QY GDPR 15 Copyright ACDC Leadership 2015

A

2008 Audit Exam C

2008 Audit Exam D

2008 Audit Exam E

2012 Exam E

AD and AS Practice Worksheet 21 Copyright ACDC Leadership 2015

What Happens In the Long-Run? 22 Copyright ACDC Leadership 2015

In the long-run, wages and costs increase If consumer spending increases, what will happen in the short-run and in the long-run? In the long-run, wages and costs increase LRAS AS1 Real GDP Price Level AS PL2 PL1 Real GDP PLe AD AD1 QY Q1 GDPR Time 23 Copyright ACDC Leadership 2015

In the long-run, wages and costs increase If consumer spending increases, what will happen in the short-run and in the long-run? In the long-run, wages and costs increase LRAS AS1 Real GDP Price Level PLe Real GDP AD1 QY GDPR Time 24 Copyright ACDC Leadership 2015

In the long-run, wages & costs eventually decrease If consumer spending decreases, what will happen in the short-run and in the long-run? In the long-run, wages & costs eventually decrease LRAS Real GDP Price Level AS AS2 PLe PL1 Real GDP PL2 AD2 AD Q1 QY GDPR Time 25 Copyright ACDC Leadership 2015

Practice 26 Copyright ACDC Leadership 2015

#1. Assume there is an increase in government spending #1. Assume there is an increase in government spending. What happens to PL and output in the short- run? LRAS Price Level AS PL and Q will Increase PL1 PLe AD1 AD QY Q1 GDPR 27 Copyright ACDC Leadership 2015

Price Level decreases and output stay s the same #2. Consumer expectations fall and consumer spending plummets. What happens to price level and output in the long-run? Price Level LRAS AS AS1 Price Level decreases and output stay s the same PLe Short Run -AD Falls, PL and Q fall Long Run- AS Increases as workers accept lower wages and production costs fall. PL goes down, Q goes back to Full Employment PL1 PL2 AD AD AD1 Q1 QY GDPR 28 Copyright ACDC Leadership 2015

Price level increases and output stays the same #3. If consumer spending increases, what happens to price level and output in the long-run? LRAS Price Level AS1 AS PL2 Price level increases and output stays the same PL1 PLe AD1 AD QY Q1 GDPR 29 Copyright ACDC Leadership 2015

2008 Audit Exam E

Economic Growth 31 Copyright ACDC Leadership 2015

If investment increases, what happens in the short-run and long-run? Capital Stock- Machinery and tools purchased by businesses that increase their output Price Level LRAS LRAS1 The PPC shifts outward since producers can make more AS AS1 Capital Goods PL1 PLe AD AD1 QY Q1 QY1 GDPR Consumer Goods 32 Copyright ACDC Leadership 2015

Only Investment causes growth since firms increase their capital stock An increase in consumption or government spending doesn’t cause economic growth. Only Investment causes growth since firms increase their capital stock Price Level LRAS1 AS1 Capital Goods PLe AD1 QY1 GDPR Consumer Goods 33 Copyright ACDC Leadership 2015

2008 Audit Exam E

2008 Audit Exam B

2012 FRQ #3

2012 FRQ #3