1. Aggregate Demand and Supply

2. Aggregate Demand and Supply

3. Aggregate Demand (AD)

4. Aggregate Demand Macro concept – WHOLE economy Formula:
The sum of all expenditure in the economy over a period of time
Macro concept – WHOLE economy
Formula:
AD = C+I+G+(X-M)
C= Consumption Spending
I = Investment Spending
G = Government Spending
(X-M) = difference between spending on imports and receipts from exports (Balance of Payments)

5. Aggregate Demand Curve
Shows the overall level of spending at different price levels

6. Aggregate Demand Curve
Why does it slope down from left to right?
Assume RBNZ sets short term interest rates
Assume a rise in the price level will be met by a rise in interest rates
Any increase in interest rates will raise the cost of borrowing:
Consumption spending (C) will fall
Investment (I) will fall
International competitiveness will decrease because $NZ will appreciate– exports fall, imports rise
Therefore – a rise in the price level leads to lower levels of aggregate demand

7. Aggregate Demand Curve
The AD diagram:
Price Level on the vertical axis – assume an initial ‘target rate’ of P1 (as measured by the CPI)
Real GDP or Real National Income or Real Output on the vertical axis (shown by the initial Y)

8. Aggregate Demand Curve
Price
Level
This level of output will be associated with a particular level of unemployment which we will call U = 5%
The lower level of National Income requires fewer units of labour – unemployment rises to 7% shown by U = 7%
At the higher Price Level of P2, rising interest rates mean that C, I and (X-M) all have negative effects on AD – NY falls to Y2
At the price level P1, the AD curve gives a level of output of Y1 P2 P1 AD Y2 Y1
Real National Income
U = 7%
U = 5%

9. Shifts in the Aggregate Demand Curve
Price
Level
This would cause a rise in national income (economic growth) and lead to a fall in unemployment (U = 2%) (and vice versa)
Any exogenous factor causing C, I or G to rise, or a trade surplus causes a shift to the right in AD
Shifts in AD will be
caused by changes in factors affecting C, I, G and (X-M) (exogenous factors)
e.g. increasing income tax rates affect consumption P1
AD2 AD Y1 Y2
Real National Income
U = 5%
U = 2%

10. Consumption Expenditure
Exogenous factors affecting consumption:
Tax rates
Incomes – short term and expected income over lifetime
Wage increases
Availability of credit
Interest rates
Wealth
Property
Shares
Savings
Bonds

11. Investment Expenditure
Spending on:
Machinery
Equipment
Buildings
Infrastructure
Influenced by:
Expected return on investment
Interest rates
Business confidence (expected future revenues)
Expected inflation rates (inflationary expectations)

12. Government Spending Defence (Army, Navy, etc) Health Education
Law and Order
Regions
Industry

13. Import Spending (negative)
Goods and services bought from abroad – represents an outflow of funds from NZ (reduces AD)

14. Export Earnings (Positive)
Goods and services sold abroad – represents a flow of funds into NZ (raises AD)

15. Aggregate Supply (AS)

16. Capacity of the Economy
Costs of Production
Technology
Education and Training
Incentives
Tax regime
Capital stock
Productivity
Labour Market

17. Aggregate Supply This shape reflects a Keynesian view of the AS curve.
Price
Level AS
Between Y1 and Yf, increases in capacity are possible but the nearer the economy gets to Yf, the more problems are experienced with acquiring resources to boost production (production bottlenecks) especially labour skills shortages.
Yf represents ‘Full Employment Output’ – at this point the economy is working to full capacity and cannot produce any more.
The shape of the AS
curve is important in
determining the outcome in the economy
An output level of Y1 would suggest the economy is working below full capacity and there would be widespread unemployment.
This shape reflects a Keynesian view of the AS curve.
Economy starts to overheat Y1 Yf
Real National Income

18. Aggregate Supply Price Level AS1 AS2
Increases in capacity can occur as a result of a shift in AS (akin to a shift outwards of the Production Possibility Frontier) (PPF)
Yf1
Yf2
Real National Income

19. Putting AD and AS together
A shift in the AD curve to AD1 as a result of a change in any or all of the factors affecting AD would increase growth, reduce unemployment but at a cost of higher inflation (a trade-off)
In this situation, the economy would be operating at less than capacity, there would be unemployment and the economy might be growing only slowly.
Price
Level P2 P1
AD 1 AD Y1 Y2 Yf
Real National Income

20. Putting AD and AS together
Further increases in AD would lead to successively smaller increases in growth and employment at the cost of ever higher inflation.
Price
Level P3
AD2 P2 P1
AD1 AD Y1 Y2 Yf Y3
Real National Income

21. Sustained Growth Price Level AS AS1 P1 AD2 AD Y1 Y2
Sustained growth (not to be confused with sustainable economic growth) occurs when AS and AD rise at similar rates – national income can rise without effects on inflation P1
AD2 AD Y1 Y2
Real National Income