Chapter 10 End of Chapter 10 ECON 151 – PRINCIPLES OF MACROECONOMICS Chapter 10: Real GDP and the Price Level in the Long Run Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved. 1

Output Growth and the Long-Run Aggregate Supply Curve The total of all planned production for the economy

Output Growth and the Long-Run Aggregate Supply Curve (cont'd) A vertical line representing the real output of goods and services after full adjustment has occurred It represents the real GDP of the economy under conditions of full employment; the economy is near its production possibilities curve 8

Figure 10-1 The Production Possibilities and the Economy’s Long-Run Aggregate Supply Curve

Output Growth and the Long-Run Aggregate Supply Curve (cont'd) LRAS is vertical Input prices fully adjust to changes in output prices Suppliers have no incentive to increase output Unemployment is at the natural rate Determined by endowments and technology (or existing resources) 10

Output Growth and the Long-Run Aggregate Supply Curve (cont'd) Growth is shown by outward shifts of either the production possibilities curve or the LRAS curve caused by Growth of population and the labor-force participation rate Capital accumulation Improvements in technology 11

Figure 10-2 The Long-Run Aggregate Supply Curve and Shifts in It

Figure 10-3 A Sample Long-Run Growth Path for Real GDP

Total Expenditures and Aggregate Demand The total of all planned expenditures in the entire economy (planned may not equal actual) Aggregate Demand Curve A curve showing planned purchase rates for all final goods and services in the economy at various price levels, all other things held constant 14

Aggregate Demand versus Demand for a Single Good When the aggregate demand curve is derived, we are looking at the entire circular flow of income and product. When a demand curve is derived, we are looking at a single product in one market only. Note the labels on the respective graphs are different. 26

Figure 10-4 The Aggregate Demand Curve As the price level rises, real GDP declines

The Aggregate Demand Curve (cont'd) What happens when the price level rises or falls? The real-balance effect (or wealth effect) The interest rate effect The open economy effect 22

The Aggregate Demand Curve (cont'd) The Real-Balance Effect The change in the real value of money balances when the price level changes The Interest Rate Effect Higher price levels indirectly increase the interest rate, which in turn causes a reduction in borrowing and spending. The Open Economy Effect Higher price levels result in foreigners’ desiring to buy fewer American-made goods while Americans desire more foreign-made goods (i.e., net exports fall). 23

Movement Along the Aggregate Demand Curve 120 GDP Deflator 90 AD 1 2 3 4 5 6 7 Real GDP per Year ($ trillions)

Shifts in the Aggregate Demand Curve Any non-price-level change that increases aggregate spending (on domestic goods) shifts AD to the right. Any non-price-level change that decreases aggregate spending (on domestic goods) shifts AD to the left. 27

Table 10-1 Determinants of Aggregate Demand

Shifts in the Aggregate Demand Curve (cont'd) Increase in aggregate demand 120 GDP Deflator 90 AD1 AD 1 2 3 4 5 6 7 Real GDP per Year ($ trillions)

Shifts in the Aggregate Demand Curve (cont'd) Decrease in aggregate demand 120 GDP Deflator 100 AD1 AD 9 10 11 12 13 14 15 Real GDP per Year ($ trillions)

Long-Run Equilibrium and the Price Level For the economy as a whole, long-run equilibrium occurs at the price level where the aggregate demand curve (AD) crosses the long-run aggregate supply curve (LRAS). 37

Figure 10-5 Long-Run Economywide Equilibrium

Long-Run Equilibrium and the Price Level (cont'd) The effects of economic growth on the price level Economic growth and secular deflation Secular Deflation A persistent decline in prices resulting from economic growth in the presence of stable aggregate demand

Secular Deflation versus Long-Run Price Stability in a Growing Economy An increase in LRAS will, ceteris paribus, result in a decrease in the price level. Avoiding secular deflation If the AD curve shifts outward by the same amount as the LRAS curve, the price level remains constant. The AD curve can be shifted outward by increasing the money supply. 41

Figure 10-6 Secular Deflation versus Long-Run Price Stability in a Growing Economy, Panel (a)

Figure 10-6 Secular Deflation versus Long-Run Price Stability in a Growing Economy, Panel (b)

Figure 10-7 Inflation Rates in the United States Source: Economic Report of the President; Economic Indicators, various issues

Figure 10-8 Explaining Persistent Inflation, Panel (a) • When LRAS1 shifts to LRAS2, the price level rises from 120 to 140 • Inflation is caused by a decrease in LRAS

Figure 10-8 Explaining Persistent Inflation, Panel (b) An increase in AD from AD1 to AD2 causes the price level to rise from 120 to 140, and an increase in AD causes inflation

Figure 10-9 Real GDP and the Price Level in the United States, 1970 to the Present

End of Chapter 10 ECON 151 – PRINCIPLES OF MACROECONOMICS Chapter 10: Real GDP and the Price Level in the Long Run Materials include content from Pearson Addison-Wesley which has been modified by the instructor and displayed with permission of the publisher. All rights reserved.