Unit 3-3: Aggregate Demand and Supply and Fiscal Policy 1

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

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

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

#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

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

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

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 8

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 9

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 10

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 11

Recessionary Gap Output low and unemployment is more than NRU LRAS Price Level AS Actual GDP below potential GDP PL1 AD1 Q1 QY GDPR 12

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 13

What Happens In the Long-Run? 14

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 15

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 16

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 17

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 18

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 19