1. From simple demand and supply in chapter 3- to aggregate demand and aggregate supply From simple demand and supply in chapter 3- to aggregate demand and aggregate supply Similar principles: Similar principles: P goes up, D goes down P goes up, D goes down PL goes up, AD goes down PL goes up, AD goes down

2. Aggregate Demand

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4. Aggregate Demand and Supply Chapters 9 and 10: fixed price level Chapters 9 and 10: fixed price level Chapter 11: variable price level Chapter 11: variable price level

5. Aggregate Demand Schedule or curve that shows the amount of real output that buyers collectively desire to purchase at each possible price level Schedule or curve that shows the amount of real output that buyers collectively desire to purchase at each possible price level Inverse Inverse PL increase, quantity of real GDP demanded decreases PL increase, quantity of real GDP demanded decreases

6. AD most important factor PL (movement) other reasons why AD increases/decreases- shift AD most important factor PL (movement) other reasons why AD increases/decreases- shift AS most important factor PL (movement) other reasons why AS increases/decreases- shift AS most important factor PL (movement) other reasons why AS increases/decreases- shift

7. AD AS 1. change in consumer spending 1. change in consumer spending Change in investment spending Change in investment spending Change in Government spending Change in Government spending Change in net export spending Change in net export spending Change in input prices Change in input prices Change in productivity Change in productivity Change in legal- institutional environment Change in legal- institutional environment

8. Aggregate Demand Curve

9. Why downward slope? Single product demand: income effect and substitution effect Single product demand: income effect and substitution effect When price of individual product falls, consumers have more money, buy more When price of individual product falls, consumers have more money, buy more Aggregate demand: when general price level decreases, there is less nominal income flowing to suppliers in form of wages, rents, interests, etc. Aggregate demand: when general price level decreases, there is less nominal income flowing to suppliers in form of wages, rents, interests, etc. This means people as a whole are earning less! This means people as a whole are earning less!

10. Substitution effect Works for individual item Works for individual item There is no overall substitution effect among domestically produced goods when the price level falls There is no overall substitution effect among domestically produced goods when the price level falls

11. 3 Reasons for downward slope of aggregate demand (cause a movement, not shift b/c they relate to change in PL) Real-balance effect Real-balance effect Interest-rate effect Interest-rate effect Foreign purchase effect Foreign purchase effect

12. Real-Balances Effect Change in price level produces a real-balance effect Change in price level produces a real-balance effect Higher price level reduces real value or purchasing power of people’s savings Higher price level reduces real value or purchasing power of people’s savings Example- you might buy new car if you have 50,000 in savings, but with inflation if the money is only worth 30,000 you might hold off Example- you might buy new car if you have 50,000 in savings, but with inflation if the money is only worth 30,000 you might hold off

13. Interest-rate effect When price level rises, consumers need more money for purchases and businesses need more money to meet payroll, etc. When price level rises, consumers need more money for purchases and businesses need more money to meet payroll, etc. Increase in demand for money will drive up the price paid for its use---- INTEREST Increase in demand for money will drive up the price paid for its use---- INTEREST Increasing demand for money and interest rate, a higher price level reduces the amount of real output demanded Increasing demand for money and interest rate, a higher price level reduces the amount of real output demanded

14. Foreign Purchases Effect Rise in price level reduces the quantity of U.S. goods demanded. (foreigners buy fewer American goods and Americans buy more foreign goods) Rise in price level reduces the quantity of U.S. goods demanded. (foreigners buy fewer American goods and Americans buy more foreign goods)

15. Determinants of Aggregate Demand Causes aggregate demand curve to shift (other than change in price level…movement) Causes aggregate demand curve to shift (other than change in price level…movement) 1. change in consumer spending 1. change in consumer spending 2. change in investment spending 2. change in investment spending 3. change in government spending 3. change in government spending 4. change in net export spending 4. change in net export spending

16. Change in consumer spending Several factors other than a change in price level may change consumer spending and thus shift aggregate demand curve Several factors other than a change in price level may change consumer spending and thus shift aggregate demand curve 1. Consumer wealth (example– doing well in stock market) 2. Consumer expectations- when people expect their future incomes to rise, they spend more of current income, people expect huge inflation, will buy more now, lower future income expectations or lower prices in future will decrease AD

17. Changes in investment spending Real interest rates- increase in money supply lowers the interest rate, increasing investment, dec. in money supply, raises interest rate, dec AD Real interest rates- increase in money supply lowers the interest rate, increasing investment, dec. in money supply, raises interest rate, dec AD Expected Returns- higher returns increase AD Expected Returns- higher returns increase AD a. Expectations about future business conditions b. Technology c. Degree of excess capacity- rise in unused capital will reduce expected rate of return and reduce AD d. Business taxes- AD decline if they increase and AD will increase if they decrease

18. Government Spending Increase in Gov spending will shift AD to right Increase in Gov spending will shift AD to right

19. Change in net export spending Greater level of US exports = increase AD, lower imports- increase AD Greater level of US exports = increase AD, lower imports- increase AD These changes are not associated with PL! These changes are not associated with PL! What might change net export other than PL? What might change net export other than PL? 1. National income abroad- rising NI abroad encourages foreigners to buy more products, some of which are US made (increase AD) 2. Exchange rates- deprecation of dollar increases US exports- AD shift to right

20. Aggregate Supply Schedule or curve showing the level of real domestic output that firms will produce at each price level Schedule or curve showing the level of real domestic output that firms will produce at each price level Has 3 distinct segments or ranges- horizontal range, intermediate range, vertical range (pg 210) Has 3 distinct segments or ranges- horizontal range, intermediate range, vertical range (pg 210)

21. Aggregate Supply

22. Horizontal range Includes only levels of real output that are substantially less than the full-employment output Includes only levels of real output that are substantially less than the full-employment output Economy is in a recession or depression and large amounts of machinery and equipment and unemployed workers available for production Economy is in a recession or depression and large amounts of machinery and equipment and unemployed workers available for production If real output falls, product and resource prices will not move downward If real output falls, product and resource prices will not move downward

23. Intermediate (upsloping range) Expansion of real output is accompanied by rising price level Expansion of real output is accompanied by rising price level

24. Vertical range Increases of price level in this range will produce no additional output since the economy already is operating at its full capacity Increases of price level in this range will produce no additional output since the economy already is operating at its full capacity

25. Determinants of Aggregate Supply 1. change in input price 1. change in input price 2. change in productivity 2. change in productivity 3. change in legal-instituted environment 3. change in legal-instituted environment

26. Change in input price Higher input price increase per-unit production costs and reduce aggregate supply Higher input price increase per-unit production costs and reduce aggregate supply Factors that influence input prices: Factors that influence input prices: * Domestic resource availability- increases in supply of domestic resources will lower resource prices, reduce per-unit production costs, and shift aggregate supply curve to the right * Domestic resource availability- increases in supply of domestic resources will lower resource prices, reduce per-unit production costs, and shift aggregate supply curve to the right A. Land- expansion will increase supply, vice versa A. Land- expansion will increase supply, vice versa B. labor- increase in labor reduces price of labor, shifting labor to right B. labor- increase in labor reduces price of labor, shifting labor to right C. Capital- replacing old capital with new- shift to right, destruction of capital due to war- shift to left C. Capital- replacing old capital with new- shift to right, destruction of capital due to war- shift to left D. Entrepreneurial ability- D. Entrepreneurial ability-

27. Price of Imported Resources Decrease in price of imported resources increase U.S. aggregate supply, increase in their price reduces U.S. aggregate supply Decrease in price of imported resources increase U.S. aggregate supply, increase in their price reduces U.S. aggregate supply

28. Market Power Change in degree of market power- the ability to set above-competitive prices can affect input prices and aggregate supply Change in degree of market power- the ability to set above-competitive prices can affect input prices and aggregate supply Example- OPEC Example- OPEC

29. Productivity (second major determinate of AS) (second major determinate of AS) A measure of the relationship between a nation’s level of real output and the amount of resources used to produce it. A measure of the relationship between a nation’s level of real output and the amount of resources used to produce it. Productivity = total output/ total input Productivity = total output/ total input

30. Legal-Institutional Environment Business taxes and subsidies Business taxes and subsidies Government regulation Government regulation

31. Intersection of AD and AS determines the economy’s Equilibrium price level and equilibrium real output Equilibrium price level and equilibrium real output AD/AS curve may intersect in different ranges (horizontal, intermediate, vertical) AD/AS curve may intersect in different ranges (horizontal, intermediate, vertical)

32. Changes in Equilibrium How will a change in AD demand impact the economy? It depends on where we are (horizontal, intermediate, vertical) How will a change in AD demand impact the economy? It depends on where we are (horizontal, intermediate, vertical) Increase in AD in horizontal range- no inflation, intermediate- inflation (demand-pull inflation) vertical (demand-p`ull inflation) Increase in AD in horizontal range- no inflation, intermediate- inflation (demand-pull inflation) vertical (demand-p`ull inflation)

33. In the horizontal range of AS, the full strength of the multiplier works! In the horizontal range of AS, the full strength of the multiplier works! In contrast, if the economy is in the intermediate or vertical range of the AS curve, part or all of any initial increase in AD will be dissipated in inflation and therefore will not reflect an increase in real output In contrast, if the economy is in the intermediate or vertical range of the AS curve, part or all of any initial increase in AD will be dissipated in inflation and therefore will not reflect an increase in real output Any initial increase in AD, the resulting increase in real GDP will be smaller the greater the increase in PL Any initial increase in AD, the resulting increase in real GDP will be smaller the greater the increase in PL

34. Decreases in AD in horizontal range signal recession and cyclical unemployment Decreases in AD in horizontal range signal recession and cyclical unemployment Real output takes the full brunt of the decline in AD because it occurs in the horizontal range of AS where sometimes there is no price flexibility Real output takes the full brunt of the decline in AD because it occurs in the horizontal range of AS where sometimes there is no price flexibility Why? Why?

35. Numerous reasons for downward price inflexibility Wage contracts Wage contracts Morale, effort, productivity- efficiency wages- wages that elicit maximum work effort and thus minimize labor cost per unit of output- some employers are not willing to lower wages and morale Morale, effort, productivity- efficiency wages- wages that elicit maximum work effort and thus minimize labor cost per unit of output- some employers are not willing to lower wages and morale Minimum wage Minimum wage Menu costs- cost of printing new catalogs, etc when changing price Menu costs- cost of printing new catalogs, etc when changing price Fear of price wars Fear of price wars