1 © ©1999 South-Western College Publishing PowerPoint Slides prepared by Ken Long Principles of Economics 2nd edition by Fred M Gottheil

2 Chapter 19 Aggregate Demand and Aggregate Supply 1/11/2016 © ©1999 South-Western College Publishing

3 This chapter discusses principles associated with Demand Pull & Supply Push Inflation © ©1999 South-Western College Publishing Macroeconomic Equilibrium Aggregate Demand and Aggregate Supply Nominal and Real GDPThe CPI and GDP DeflatorGross Domestic Product The Phases of the Business Cycle

4 What is a Recession? A phase in the business cycle in which unemployment is relatively high and the rate of economic growth relatively low. © ©1999 South-Western College Publishing

5 What is a Depression? A severe recession © ©1999 South-Western College Publishing

6 What is Prosperity? A phase in the business cycle marked by a relatively high level of real GDP, full employment, and inflation © ©1999 South-Western College Publishing

7 What is Inflation? An increase in the price level © ©1999 South-Western College Publishing

8 What is the Business Cycle? Alternating periods of growth and decline in an economy’s GDP © ©1999 South-Western College Publishing

9 What are the four stages of the Business Cycle? © ©1999 South-Western College Publishing Trough or recession recovery peak or prosperity downturn

10 Aggregate Output Time The Business Cycle Peak Trough 10

11 How do we measure Economic Growth? Change in Domestic Product © ©1999 South-Western College Publishing

12 What is Gross Domestic Product? GDP is the total value of all final goods and services measured in current market prices, produced in the economy in any one year © ©1999 South-Western College Publishing

13 What is a Final Good? A good that is not itself used to produce other goods © ©1999 South-Western College Publishing

14 What does “measured in current market prices” mean? The year in which the good was made, the current market price © ©1999 South-Western College Publishing

15 What does “produced in the economy” mean? It is produced domestically © ©1999 South-Western College Publishing

16 For the latest measure of GDP visit - fsbr/esbr.html © ©1999 South-Western College Publishing

17 What is Nominal GDP? GDP measured in terms of current market prices - it is not adjusted for inflation © ©1999 South-Western College Publishing

18 What is Real GDP? GDP adjusted for changes in the price level © ©1999 South-Western College Publishing

19 What is a Base Year? The reference year with which prices in other years are compared. © ©1999 South-Western College Publishing

20 What is the Price Level? A measure of prices in one year expressed in relation to prices in a base year © ©1999 South-Western College Publishing

21 What is the value of the index in the base year? 100 © ©1999 South-Western College Publishing

22 If nominal GDP is $750 billion and the price index for that year is 1.11, then real GDP = $750/1.11 (or) $ © ©1999 South-Western College Publishing

23 Show me how it works Suppose the base year is 1994 With inflation of 2% in 1995, the price index would be 1.02 in 1995 With an inflation rate of 3% in 1996, the price index in 1996 would be 1.05 ( ) © ©1999 South-Western College Publishing

24 How do we compare real GDP as a percent from year to year? We take the percent increase from year to year and compare © ©1999 South-Western College Publishing

25 What is the percent increase as we go from 3 to 5? 2 / 3 = 67% © ©1999 South-Western College Publishing

26 What is the Consumer Price Index (CPI)? A measure over time of the cost of a fixed ‘market basket’ of consumer goods and services © ©1999 South-Western College Publishing

27 For the latest measure of CPI visit nomy/calc/hist1913.html © ©1999 South-Western College Publishing

28 What is the GDP Price Deflator? A measure comparing the prices of all goods and services produced in the economy during a given year to the prices of those goods and services purchased in a base year © ©1999 South-Western College Publishing

29 29 © ©1999 South-Western College Publishing Real GDP = Nominal GDP x 100 GDP Deflator

30 For current and historical data on production © ©1999 South-Western College Publishing

31 What is Aggregate Demand? The total quantity of goods and services demanded by households, firms, foreigners, and government at varying price levels © ©1999 South-Western College Publishing

32 What is Aggregate Supply? The total quantity of goods and services that firms are willing to supply at varying price levels © ©1999 South-Western College Publishing

33 Will any increase in demand cause inflation? No! It depends on where the aggregate demand curve falls on the aggregate supply curve © ©1999 South-Western College Publishing

34 Aggregate Supply Curve S d1 d2 d3 d4 d5 P Q 34 d6

35 Why is the Aggregate Supply Curve horizontal at low levels of GDP? Because so many resources are not used or are under utilized © ©1999 South-Western College Publishing

36 Why is the Aggregate Supply Curve positive at higher levels of GDP? Because we have run out of some resources so an increase in demand causes those prices to increase © ©1999 South-Western College Publishing

37 Why is Aggregate Supply perfectly vertical at higher levels of GDP? Because all resources are fully employed beyond some level of GDP © ©1999 South-Western College Publishing

38 For current wealth and income data - ncome.html © ©1999 South-Western College Publishing

39 What factors explain Aggregate Demand? Real wealth affect Interest rate effect International trade effect © ©1999 South-Western College Publishing

40 What factors cause a shift in Aggregate Demand? A change in... government spending taxes income abroad expectations © ©1999 South-Western College Publishing

41 What factors cause a shift in Aggregate Supply? A change in... resource availability wages interest rates rents © ©1999 South-Western College Publishing

42 What is Macroequilibrium? The level of real GDP and the price level that equate the aggregate quantity demanded and the aggregate quantity supplied © ©1999 South-Western College Publishing

43 AD AS P3 Q3 P1 Surplus P2 Shortage 43 © ©1999 South-Western College Publishing

44 What real world illustrations does the text use to show an outward shift in the AD curve along a horizontal AS curve? Government spending in the Great Depression Government spending during WW2 © ©1999 South-Western College Publishing

45 What real world illustrations does the text use to show an outward shift in the AD curve along an upward sloping AS curve? Government spending on the Vietnam War in the 1960’s © ©1999 South-Western College Publishing

46 What is Demand-Pull Inflation? Inflation caused primarily by an increase in aggregate demand © ©1999 South-Western College Publishing

47 What is an example of a decrease in Aggregate Supply? The OPEC legacy of the 1970’s © ©1999 South-Western College Publishing

48 What is Cost-Push Inflation? Inflation cause primarily by a decrease in aggregate supply © ©1999 South-Western College Publishing

49 What other problem can Cost-Push Inflation cause? Unemployment © ©1999 South-Western College Publishing

50 What is Stagflation? A period of stagnating real GDP, inflation, and relatively high levels of unemployment © ©1999 South-Western College Publishing

51 What is a Recession? What is a Depression? What are the four stages of the Business Cycle?What are the four stages of the Business Cycle? What is Gross Domestic Product? What is Nominal GDP? What is Real GDP?

52 What is the Consumer Price Index? What is the GDP Price Deflator? What is Aggregate Demand? What is Aggregate Supply? What is Macroequilibrium? What is Stagflation?

53 ENDEND © ©1999 South-Western College Publishing