 Aggregate demand: Schedule indicating spending plans of agents at alternative price levels. Price level Y 0 AD 1 AD 2 Any factor that would shift the AE schedule will shift AD as well

Price level Y 0 AD 1 AD 2 AD 1 to AD 2 due to: Increase in income Increase in wealth Increase in consumer or business confidence Population growth Lower taxes

Price level Y 0 AD 1  to  due to   3 The wealth effect. 3 The interest rate effect 3 The international trade effect. The interest rate effect is poorly explained by Boyes & Melvin on pp

 Aggregate supply is the schedule indicating the quantity to total output supplied at alternative price levels Price level Y 0 AS 1 AS 2 AS 1  AS 2 due to: Rising input prices (wages, intermediate goods, raw materials) Decreased productivity

Productivity (  ) means the average output of a worker per year, or alternatively:  = Y/N where N is total employment.  depends on the efficiency with which labor is employed in the production of goods & services

 Let  denote average annual compensation of employees (including benefits). Thus unit labor cost (UCL) is defined as: ULC =  /  Notice that compensation can rise with no effect on ULC, so long as productivity keeps pace

Price level YY1Y1 AS 1 AS 2 An increase in ULC at every level of Y will shift AS to the left 0 P1P1 P2P2

Price level Y 0 AS AD 1 AD 2 22 11 Many economists think this accurately describes the U.S. situation in Notice that both Y and P increase

Y* LRAS AD 1 AD 2 P1P1 P2P2 0 Y Price level With the economy at full-employment, a change in AD affects prices --but not output, real income, or employment

Price level Y 0 AS 1 AD AS 2 Y2Y2 Y1Y1 P1P1 P2P2 Cost-push is a drag since Y decreases and P increases

Grain failures Anchovies Oil shocks Wage and salary pressures Stagflation is the simultaneous presence of high inflation and unemployment

Source: The Petroleum Economist I’d call that a shock, wouldn’t you? The story of Joseph (see Old Testament) suggests buffer stocks as the remedy for supply-shock inflation Price of One Barrel of 34 0 crude oil

Source: Economic Report of the President