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

2. Shifters of Aggregate Demand Shifters of Aggregate Supply
AD = C + I + G + X
Change in Consumer Spending
Change in Investment Spending
Change in Government Spending
Net EXport Spending
Shifters of Aggregate Supply
AS = R + A + P
Change in Resource Prices
Change in Actions of the Government
Change in Productivity

3. Putting AD and AS together to get Equilibrium Price Level and Output

4. Use the AD and AS model to show an economy at full employment output
LRAS
Price Level AS
PLe AD QY
GDPR 4

5. #1. Assume there is an increase in consumer spending
#1. Assume there is an increase in consumer spending. What happens to PL and output in the short- run?
LRAS
Price Level AS
PL and Q will Increase
PL1
PLe
AD1 AD QY Q1
GDPR 5

6. Practice
AD or AS
Shifter
Increase or Decrease 1 2 3 4 5 6 7 8 9 10

7. Practice An increase in consumer spending
The impact on net exports when a trading partner has a recession
A significant increase in the price of oil that affects the resource costs of businesses
Government increases spending but not taxes
Increase in wages that businesses pay workers
Effect on businesses when they expect inflation
Effect on investment when interest rates decrease
An increase in productivity
The impact on next exports when the country’s currency depreciates
Government increases corporate taxes 7 7

8. The economy can only be in one of three places at any time
Max Capacity
0% Unemployment
Real GDP
Capital Goods
Real
GDP
Consumer Goods
Time
Recessionary Gap
Full Employment
5% Unemployment
Full Employment
Inflationary Gap 8

9. Example: Assume the government increases spending
Example: Assume the government increases spending. What happens to PL and Output?
LRAS
Price Level AS
PL and Q will Increase
PL1
PLe
AD1 AD QY Q1
GDPR 9

10. 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 10

11. Example: Assume consumer spending falls. What happens to PL and Output?
LRAS
Price Level AS
PL and Q will decrease
PLe
PL1 AD
AD1 Q1 QY
GDPR 11

12. Recessionary Gap Output low and unemployment is more than NRU LRAS
Price Level AS
Actual GDP below potential GDP
PL1
AD1 Q1 QY
GDPR 12

13. Stagnate Economy + Inflation Still considered recessionary gap
Example: If there is a negative “supply shock” of oil. What happens to PL and Output?
LRAS
Price Level
AS1 AS
Stagflation
Stagnate Economy + Inflation
PL1
PLe
Still considered recessionary gap AD Q1 QY
GDPR 13

14. What Happens In the Long-Run?14

15. In the long-run, wages and costs increase
If consumer spending increases, what will happen in the short-run and in the long-run?
In the long-run, wages and costs increase
LRAS
AS1
Real GDP
Price
Level AS
PL2
PL1
Real GDP
PLe AD
AD1 QY Q1
GDPR
Time 15

16. In the long-run, wages and costs increase
If consumer spending increases, what will happen in the short-run and in the long-run?
In the long-run, wages and costs increase
LRAS
AS1
Real GDP
Price
Level
PLe
Real GDP
AD1 QY
GDPR
Time 16

17. In the long-run, wages & costs eventually decrease
If consumer spending decreases, what will happen in the short-run and in the long-run?
In the long-run, wages & costs eventually decrease
LRAS
Real GDP
Price
Level AS
AS2
PLe
PL1
Real GDP
PL2
AD2 AD Q1 QY
GDPR
Time 17

18. If investment increases, what happens in the short-run and long-run?
Capital Stock- Machinery and tools purchased by businesses that increase their output
Price
Level
LRAS
LRAS1
The PPC shifts outward since producers can make more AS
AS1
Capital Goods
PL1
PLe AD
AD1 QY Q1
QY1
GDPR
Consumer Goods 18

19. Only Investment causes growth since firms increase their capital stock
An increase in consumption or government spending doesn’t cause economic growth.
Only Investment causes growth since firms increase their capital stock
Price
Level
LRAS1
AS1
Capital Goods
PLe
AD1
QY1
GDPR
Consumer Goods 19