NATIONAL INCOME AND THE PRICE LEVEL IN THE SHORT RUN Chapter 31 - Lipsey

EXOGENOUS CHANGES IN THE PRICE LEVEL SHIFTS IN THE AE CURVE in the price level: AE curve shifts downward, in the price level: AE curve shifts upward. In other words, the price level and AE are negatively related to each other. CHANGES IN CONSUMPTION Inside Assets: issued by someone in private sector but held by someone else in private sector. Outside Assets: held by someone in private sector but issued by someone outside that sector. CHANGES IN NET EXPORTS - in P shifts net exports function downward

CHANGES IN EQUILIBRIUM INCOME (Fig. 31.1) in Price Downward shift in AE in real national income. in Price Upward shift in AE in real national income. THE AGGREGATE DEMAND CURVE (Fig. 31.2) in P leads to a new AE curve and hence a new level of income. Each combination of price & income becomes a particular point on the AD curve. Slope of the AD curve Points off the AD curve (fig.31.3) Shifts in the AD curve The simple multiplier and the AD curve (31. 4)

EQUILIBRIUM NATIONAL INCOME & THE PRICE LEVEL THE AGGREGATE SUPPLY CURVE Relates aggregate supply to the price level 2 TYPES Short-Run Aggregate Supply Curve (SRAS) – fig 31.5 Assumption: prices of all factors of production remain constant. Long-Run Aggregate Supply Curve (LRAS) Relates price and output after the economy has fully adjusted to that price level.

THE SLOPE OF THE SRAS CURVE SHIFTS IN THE SRAS CURVE Costs & Output: are positively related. Prices & Output: positively associated due to actions of price-takers and prices-setters . Real & Nominal Wages: in the price and output level is associated with a fall in real wage i.e. a rise in the price of output relative to input prices. SHIFTS IN THE SRAS CURVE Also known as aggregate supply shocks Two important sources Change in input prices Increase in productivity

MACROECONOMIC EQUILIBRIUM – fig 31.7 Refers to equilibrium values of national income and the price level, as determined by the intersection of the AD and SRAC curves. Shifts in AD also known as Aggregate Demand shocks (fig 31.8) Shifts in SRAS also known as Aggregate supply shocks (fig 31.12) These shocks change the equilibrium level of income and price.

CHANGES IN NATIONAL INCOME & THE PRICE LEVEL The division of effect between P and Y depends on the shape of the SRAS curve When SRAS is positively sloped: AD shocks cause P and Y to move in same direction. The multiplier is smaller than the simple multiplier. When SRAS is flat: shifts in AD primarily affect Y. When SRAS is steep: shifts in AD primarily affect P.

CHANGES IN NATIONAL INCOME & THE PRICE LEVEL An aggregate supply shock moves equilibrium Y along the AD curve, causing the P and Y to move in opposite directions. A left-ward shift in the SRAS curve causes stagflation i.e. P and Y. A right-ward shift in the SRAS curve causes an in Y and a in P. The division of effect of a shift in SRAS between a change in Y and P depends on the shape of the AD curve.