1. How can we analyze economic fluctuations?
Aggregate Demand and Aggregate Supply

2. Event: Government Intervention
The Aggregate Model
Used to explain or predict the effects of macroeconomic events or policies on equilibrium price and output
Effect: Uncertainty causing less consumption and investment
Lower price and gdp
Event: Tsunamis
Effect: More Governmental intervention to spend more money
Higher price and gdp
Event: Government Intervention

3. the total demand for domestic goods in an economy
Aggregate Demand
Shows the relationship between
PRICE LEVELS (y)
And
REAL GDP (X)
the total demand for domestic goods in an economy
GDP = Consumption + Investment + Government Spending + Exports –
Imports

4. What does this look like?

5. Why is it downward sloping?
1) Foreign Sector Substitution effect:
If prices rise domestically
Look internationally
If prices fall domestically
Buy more domestically

6. Why is it downward sloping?
2) Interest rate effect:
If prices rise 
Need to borrow more
Interest rates rise
Investment falls
Consumption falls
If prices fall 
Need to borrow less
Interest rates fall
Investment increases
Consumption increases

7. Why is it downward sloping?
3) The Wealth effect:
If price rises 
The purchasing power falls
The quantity of domestic output demanded falls

8. Changing any of the components:
How do we shift AD?
Changing any of the components:
Consumption
Investment
Government Spending
Exports
Imports

9. Shifts of AD Consumption will… Investment will… Increase AD if…
Decrease AD if…
More wealth
Less wealth
More optimistic
Less optimistic
Less taxes
More taxes
Increase AD if…
Decrease AD if…
Lower real interest rate
Higher real interest rate
Higher expected returns
Lower expected returns
Due to future expectations about profitability

10. AD SHIFTS: G and NX (X-M)
Government spending will
Net Exports
Increase AD if…
Decrease AD if…
Weak Domestic Currency
(more exports, less imports)
Strong Domestic Currency
(less exports, more imports)
Strong Foreign Economies
(Export more)
Weak Foreign Economies
(we export less)
Increase AD with more spending
Decrease AD with less spending

11. Representations of Shifts in the AD
Increase of AD (right)
Decrease in AD (left)

12. How would you bolster Japan’s Aggregate Demand?
As a team of economists, you receive $1 million dollars to help “bolster” the Japanese economy. Strategize how you will use this money to increase your component of Aggregate Demand after the tsunami and earthquake in Japan.
How will your response “rebuild” the economy?

13. MPC
MPC in Economics means Marginal Propensity to Consume. This refers to the means of measuring the proportion of how much is spent to how much is saved. This is known in business but is actually commonly used by individuals on their everyday lives and on how they budget.

14. Government Spending Multiplier
Change to any component of AD
(C + Ig + G + Xn) has a “ripple effect”
Results in a multiplied effect on GDP
Important as a small change in spending leads to a large change in GDP
Calculated by: or
MPS MPC

15. Government Spending Multiplier
Examples: 1/MPS
.25 MPS change = multiplier of 4
.33 MPS change = multiplier of 3
MPC of .75 = 1/.25 (MPS) = multiplier of 4
If gov spending increases by $20 X 4 = GDP increases by $80

16. Aggregate Supply
PL (Y)
And
Real GDP (x)
the summation of all individual supply curves in an economy or total output in an economy

17. SHORT RUN VS. LONG RUN
SHORT RUN: PD. OF TIME WITH STICKY PRICES AND WAGES
LONG RUN: PD. OF TIME WHEN PRICES AND WAGES ARE FLEXIBLE
Input $ do not adjust to changes in the Price Level
Keynesian school
Input $ are flexible and adjust to changes in Price Level
Classical school

18. Short-Run Aggregate Supply (SRAS)
As prices increase:
Firms produce more for a greater profit
As prices decrease:
sales will fall, and producers produce less PL
SRAS
GDPR

19. Productivity (technology) Input Prices Laws, regulations, taxes
HOW TO SHIFT THE SRAS
Productivity (technology)
Input Prices
Laws, regulations, taxes
Expected Inflation

20. Shifts of SRAS Productivity will… Input Prices will… Increase SRAS if…
Decrease SRAS if…
Improvements in technology
Natural Disasters destroy resources
Novel Techniques introduced
Labor Force is reduced in size because of strikes or epidemics
Increase SRAS if…
Decrease SRAS if…
Lower cost of production
Higher cost of production

21. Shifts of SRAS Laws and Regulations will… Expected Inflation will…
Increase SRAS if…
Decrease SRAS if…
Lower taxes
Higher taxes
Lower wages
Higher wages
Increase SRAS if…
Decrease SRAS if…
Prices are expected to

22. INCREASE AND DECREASE IN SRAS
DECREASE IN INPUT COSTS
INCREASE IN INPUT COSTS
SRAS1 PL
SRAS PL
SRAS1 PL
SRAS
GDPR
GDPR

23. Long-Run Aggregate Supply (LRAS)Yf
GDPR

24. HOW TO SHIFT THE LRAS CHANGE IN TECHNOLOGY
LIKE THE PPF
In the Long run, we are at Full Employment (3-5% unemployment)
CHANGE IN TECHNOLOGY
CHANGE IN LABOR PRODUCTIVITY
Increase the Human Capital, or skill level of the workers
CHANGE IN CAPITAL

25. Aggregate Supply and Demand Practice
Number
Scenario 1
The government increases expenditures on education. 2
There is an increase in the price of oil. 3
Businesses face a pollution tax for their externalities. 4
The value of the yen increases. 5
New technology and better education increase productivity. 6
Interest rates fall with an increase in the money supply (show the effect on AD only) 7
There is an increase in investment across the nation after the tsunami. 8
Unions become more aggressive and wage rates increase. 9
Consumers (not producers) become more confident about the future. 10
Honda cars become extremely popular globally.

26. Answers 1 AD increase: Government 2 AS decrease: Input Costs 3
AS decrease: Legal Requirements 4
AD decrease: Exports and Imports (NX) 5
AS increase: Productivity 6
AD increase: Consumption and Investment 7
AD increase: Investment 8 9
AD increase: Consumption 10
AS decrease: Expectations

27. Macroeconomic Equilibrium
Intersection between SRAS and AD determines price level (PL) and the current output (GDP) PL
LRAS
SRAS P AD Yf
GDPR
Full employment = Yf, any distance away from FE shows unemployment

28. Inflationary Gap Equilibrium occurs to the right of full employment
LRAS
SRAS PL P AD YF Y
GDPR

29. Equilibrium occurs to the left of full employment 
Recessionary Gap
Equilibrium occurs to the left of full employment 
SRAS
LRAS PL P AD Yf
GDPR Y

30. The Phillips Curve (I O U)
Basic Assumptions:
Inverse relationship between inflation and unemployment
If inflation demand pull
If deflation recession
Movement along curve changes during business cycle as represented by an increase or decrease of AD

31. Shows the relationship between inflation and unemployment
The Phillips Curve i . . . 4% . . . 2% . PC 5% 7% u
Shows the relationship between inflation and unemployment

32. Effect: Causes movements along the curve
Increase in AD PL i%
LRAS . .
SRAS
SRPC  . . P1
i 1    P i
AD1 AD   Y YF
GDPR un u u%
Effect: Causes movements along the curve

33. Leftward Shift of Aggregate Supply
SRAS1
SRPC1 i PL
LRAS
LRPC
SRAS
SRPC . .   . . P1 i1   P i AD   Y1 YF
GDPR un u1 u%
Effect: causes a rightward shift of the Short-run Phillips Curve
Stagflation: Increase in Price and Decrease in Output (1970s)

34. The Short-Run Phillips Curve (SRPC). . . . . . . . . . 4% . . .
SRPC1 2% .
SRPC 5% 7% u
An increase in the SRPC arises from a leftward shift of the SRAS

35. The Phillips Song
AD Slides it up or down, up or down, up or down, SRAS Shifts it in or out Inflation, Unemployment

36. The Long Run Phillips Curve
The economy can adjust to inflation in the long run due to real wages.
The LRPC is vertical at the Natural Rate of Unemployment
Increases in the unemployment rate because of more unemployment compensation  rightward shift
Decreases in the unemployment rate because of less unemployment compensation  leftward shift

37. THE SRPC and the LRPC inflation unemployment SRPC 1 LRPC 1 % uN% A
A movement from A to B arises from a cyclical change.
A shift from SRPC 1 to SRPC 2 arises from a decrease in the SRAS curve. B C 
2 % 
SRPC 2 u%
unemployment

38. Practice FRQ
Assume an economy is operating at full employment. A major political event stops the delivery of foreign oil to the country.
a) Draw the Aggregate Model to show how this event affects macroeconomic equilibrium. (Include the SRAS, AD, and LRAS curves.)
b) Show how this change affects the Short Run Phillip’s Curve.
c) Because of this event, the government is unable to provide unemployment compensation for federal workers. Show the change on the LRPC. Use 4% as the original LRPC.