1. Unit 3: Aggregate Demand and Supply and Fiscal Policy1

2. What are the shifters of Aggregate Demand?
AD = C + I + G + X
Change in Consumer Spending
Change in Investment Spending
Change in Government Spending
Net EXport Spending
What are the shifters of Aggregate Supply
AS = I + R + A + P
Change in Inflationary Expectations
Change in Resource Prices
Change in Actions of the Government
Change in Productivity (Investment)

3. Practice 3

4. Answer and identify shifter: C.I.G.X or I.R.A.P
A. in AD B. in AD C. in AS D. in AS B
____ 1. A decrease in consumer spending? ____ 2. The impact on net exports caused by increases in the national incomes of our major trading partners? ____ 3. A large increase in the price of imported oil which impacted the resource cost of businesses? ____ 4. A large increase in government spending on our highway system? ____ 5. A substantial increase in wages that businesses pay their workers? ____ 6. The effect on investment if there are negative business profit expectations? (We are headed into a recession) ____ 7. A decrease in interest rates even though there is no change in price level? ____ 8. The government picking up the tuition tab for all of the nation’s school students who have made a “90” or above in high school AP Econ. ____ 9. A major increase in productivity? ____ 10. The effects of a 25% stock market increase over a two month period? A D A D B A A C A

5. Inflationary and Recessionary Gaps
Putting AD and AS together to get Equilibrium Price Level and Output
Inflationary and Recessionary Gaps

6. Example: Assume the government increases spending
Example: Assume the government increases spending. What happens to PL and Output?
LRAS
Price Level AS PL Q
PL1
PLe
AD1 AD QY Q1
GDPR 6

7. 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 7

8. Recessionary Gap PL Q Output low and unemployment is more than NRU
Example: People fear a terrorist attack and stop shopping. What happens to PL and Output?
Output low and unemployment is more than NRU
LRAS PL Q
Price Level
AS1
PL1
Actual GDP below potential GDP
AD1
AD2 Q1 QY
GDPR 8

9. Stagnate Economy + Inflation
Example: Assume the price of oil increases drastically. What happens to PL and Output?
LRAS
Price Level
AS1 AS PL Q
PL1
PLe
Stagflation
Stagnate Economy + Inflation AD Q1 QY
GDPR 9

10. AD and AS Practice 10

11. How does this cartoon relate to Aggregate Demand?11

12. Question 1: Calvin/children convince parents
Price
Level AS
Original Line
ADé
Shifter:
Consumer Spending
New Line
What type of Gap?
Inflationary P1 P
AD1 AD
LRAS
GDP Q Q1

13. Question 2: Effect on production—5% Tax
Price
Level
AS1 AS
Original Line
ASê
Shifter:
Government Action
New Line
What type of Gap?
Recessionary P1 P AD
LRAS
GDP Q1 Q

14. Question 3: Russia buys US wheat products
Price
Level AS
Original Line
ADé
Shifter:
Net Exports
New Line
What type of Gap?
Inflationary P1 P
AD1 AD
LRAS
GDP Q Q1

15. Price AS Level Original Line ADê Shifter: New Line P P1 AD AD1 LRAS
Question 4: A cut in Federal spending for Health care
Price
Level AS
Original Line
ADê
Shifter:
Government Spending
New Line
What type of Gap?
Recessionary P P1 AD
AD1
LRAS
GDP Q1 Q

16. Price AS Level Original Line ASé Shifter: AS1 New Line P P1 AD LRAS
Question 5: OPEC DIES—Oil Natural Resources become cheaper
Price
Level AS
Original Line
ASé
Shifter:
Resource Price
New Line
What type of Gap?
Inflationary
AS1 P P1 AD
LRAS
GDP Q Q1

17. Question 6: Personal income tax 
Price
Level AS
Original Line
ADé
Shifter:
Consumer Spending
New Line
What type of Gap?
Inflationary P1 P
AD1 AD
LRAS
GDP Q Q1

18. Question 7: Increase in labor productivity
Price
Level AS
Original Line
ASé
Shifter:
Productivity
New Line
What type of Gap?
Inflationary
AS1 P P1 AD
LRAS
GDP Q Q1

19. Price AS Level Original Line ADê Shifter: New Line P P1 AD AD1 LRAS
Question 8: Recession in country that imports US products
Price
Level AS
Original Line
ADê
Shifter:
Net Exports
New Line
What type of Gap?
Recessionary P P1 AD
AD1
LRAS
GDP Q1 Q

20. Question 9: Effect on investment: Gov’t  money
supply, interest rates 
Price
Level AS
Original Line
ADé
Shifter:
Investment
New Line
What type of Gap?
Inflationary P1 P
AD1 AD
LRAS
GDP Q Q1

21. Question 10: Fear of a new depression by consumers
Price
Level AS
Original Line
ADê
Shifter:
Consumer Spending
New Line
What type of Gap?
Recessionary P P1 AD
AD1
LRAS
GDP Q1 Q

22. Question 11: Government increases spending on public works projects
Price
Level AS
Original Line
ADé
Shifter:
Government Spending
New Line
What type of Gap?
Inflationary P1 P
AD1 AD
LRAS
GDP Q Q1

23. Question 12: A 12% decrease in nominal wages
Price
Level AS
Original Line
ASé
Shifter:
Resource Price
New Line
What type of Gap?
Inflationary
AS1 P P1 AD
LRAS
GDP Q Q1

24. Short Run and Long Run 24

25. Shifts in AD or AS change the price level and output in the short run
LRAS
Price Level AS
PLe AD QY
GDPR 25

26. Example: Assume consumers increase spending
Example: Assume consumers increase spending. What happens to PL and Output?
LRAS
Price Level AS
PL1
PLe
AD1 AD QY Q1
GDPR 26

27. Now, what will happen in the LONG RUN?
Inflation means workers seek higher wages and production costs increase
LRAS
Price Level
AS1 AS
PL2
Back to full employment with higher price level
PL1
PLe
AD1 AD QY Q1
GDPR 27

28. AS increases as workers accept lower wages and production costs fall
Example: Consumer expectations fall and consumer spending plummets. What happens to PL and Output in the Short Run and Long Run?
Price Level
LRAS AS
AS1
AS increases as workers accept lower wages and production costs fall
PLe
Short Run -AD Falls, PL and Q fall
Long Run- AS Increases as workers accept lower wages and production costs fall. PL goes down, Q goes back to Full Employment
PL1
PL2 AD AD
AD1 Q1 QY
GDPR 28