1. Unit 3
Aggregate Demand and Aggregate Supply: Fluctuations in Outputs and Prices

2. Keynesian Model
Purpose of this lesson is to develop a simple model of the economy
GDP = C+Ig+G+Xn
Planned consumption, Gov’t spending, & net exports always occur
Planned investment does not necessarily occur
Sometimes inventories accumulate more than businesses plan, and sometimes businesses draw down inventories more than planned

3. What to do with your income?
You can do three things
Consume or Save
Y = C + S
Y = Income
C = Consumption
S = Savings
What about taxes?
Disposable Income = Income - Taxes

4. Propensities to Consume or Save
Average Propensity to Consume (APC)
APC = C / DI
Average Propensity to Save (APS)
APS = S / DI
Marginal Propensity to Consume (MPC)
MPC = ΔC / ΔDI
Marginal Propensity to Save (MPS)
MPS = ΔS / ΔDI
APC + APS = 1 and MPC + MPS = 1

5. Multiplier Effect
Effect on equilibrium GDP of a change in aggregate expenditures or aggregate demand (caused by a change in the consumption schedule, investment, government purchases, or net exports)

6. Investment To an economist, investment is
Spending on plant and equipment: the machinery and the buildings that a firm uses to produce output
Investment is not the purchase of stocks and bonds or any other financial instrument

7. Determinants of Investment
Output
Real GDP determines investment because it is a measure of the level of demand for a product
Businesses will calculate expected profitability of the investment alternatives
Interest Rate
Represents the opportunity cost of using the money to buy investment goods

8. When should businesses invest?
Expected profit > Interest Rate INVEST
Expected profit < Interest Rat DON’T INVEST
As the interest rate goes down, the level of investment goes up. (Investment is an inverse function of the interest rate)

9. Aggregate Demand Aggregate Demand
The sum of planned consumption, investment, government and export minus import expenditures on final goods and services
The aggregate demand function is an inverse function between the price level and output
As the price level rises, the level of output demanded decreases
As the price level falls, the level of output demanded increases

10. Factors that affect Aggregate Demand
Interest-rate effect
Tendency for increases in the price level to increase the demand for money, raise interest rates, and as a result, reduce total spending and real output
Wealth effect (Real-Balances Effect)
Tendency for increases in the price level to lower the real value of financial assets with fixed money value and, as a result, to reduce total spending and real GDP, and conversely for decreases in the price level
Net export effect (Foreign Purchase Effect)
The inverse relationship between the net exports of an economy and its price level relative to foreign price levels

11. Changes in expectations of future income, inflation or profits
Determinants of Aggregate Demand: Factors that shift the Aggregate Demand Curve
Changes in expectations of future income, inflation or profits
Changes in government spending or taxes
Changes in the money supply
Changes in the foreign exchange rate or foreign income

12. Aggregate Supply Aggregate Supply Aggregate Supply Curve
The total supply of all goods and services in the economy
Aggregate Supply Curve
Shows the relationship between total quantity of output supplied by all firms and the overall price level
It is NOT the sum of individual firm supply curves
Sometimes called a price-output adjustment curve

13. Aggregate Supply (con’t)
Aggregate Supply depends on the quantity of labor, the quantity of capital and the level of technology
In the short-run, the capital & level of technology are fixed, and only the quantity of labor changes
A short-run aggregate supply (SRAS) curve assumes the money wage, resource prices & potential GDP are constant
With these items being constant, as the overall price level rises, firms will produce more output

14. Shapes of short-run aggregate supply curve (SRAS)
Horizontal Line
Price level remains constant as real output varies
Vertical Line
Real output is constant at full capacity & only the price level can vary
Positively sloped (*usually draw it this way)
Real output and the price level are variable

15. Long-run aggregate supply (LRAS) curve
Vertical at full employment, or potential GDP
If there is an increase in the overall price level that is matched by equal percentage increases in the money-wage rate and other resource prices, the economy will remain at potential GDP
Following adjustments, the SRAS and AD curves will intersect along the LRAS curve

16. Determinants of Aggregate Supply: Factors that shift the SRAS Curve
Per-unit production costs
(average production cost of of a particular level of output)
Changes that decrease per-unit production costs shift the SRAS curve to the right
Changes that increase per-unit production costs shift the SRAS curve to the left

17. Change in productivity Change in legal-institutional environment
Determinants of Aggregate Supply: Factors that shift the SRAS Curve (con’t)
Change in input prices
Domestic Resource Availability
Land , Labor, Capital, Entrepreneurial Ability
Price of imported resources
Market Power
Change in productivity
Change in legal-institutional environment
Business Taxes & Subsidies, Gov’t regulations

18. Explain and Illustrate Top Portion of Visual 3.11
Unit III Lesson 5
Explain and Illustrate Top Portion of Visual 3.11

19. Short-Run Equilibrium
Unit III Lesson 5
Short-run macroeconomic equilibrium occurs when real GDP demanded equals real GDP supplied

20. Unit III Lesson 5
If the price level is above equilibrium, then aggregate supply is greater than aggregate demand
Firms experience an accumulation of inventory; they cut production & employment; output decreases towards equilibrium level

21. Unit III Lesson 5
If the price level is below equilibrium, then aggregate demand is greater than aggregate supply
Firms experience Inventory reduction; they increase production & employment; output increases toward equilibrium level

22. Explain and Illustrate Bottom Portion of Visual 3.11
Unit III Lesson 5
Explain and Illustrate Bottom Portion of Visual 3.11

23. Unit III Lesson 5
Use Visual 3.12 to illustrate AD and AS shifts and the effects on Price Level and Real GDP

24. Complete Activity 25 and review answers
Unit III Lesson 5
Complete Activity 25 and review answers

25. Unit III Lesson 5
Review Beginning of Activity 26 w/ students Complete Activity 26 and review answers

26. Review: Aggregate Supply and Aggregate Demand Analysis Continued
Unit III Lesson 6
Review: Aggregate Supply and Aggregate Demand Analysis Continued
Factors that shift AD
*Changes in expectations of future income, inflation or profits
*Changes in government spending or taxes
*Changes in the money supply
*Changes in the foreign exchange rate or foreign income
Factors that shift SRAS
*Change in input prices
Domestic Resource Availability
Price of imported resources
Market Power
*Change in productivity
*Change in legal-institutional environment
Business taxes & subsidies, Gov’t regulations

27. Complete Activity 27 and review answers
Unit III Lesson 6
Complete Activity 27 and review answers

28. We now turn to the long-run. Explain and Illustrate Visual 3.13
Unit III Lesson 6
We now turn to the long-run. Explain and Illustrate Visual 3.13

29. Complete Activity 28 and review answers
Unit III Lesson 6
Complete Activity 28 and review answers

30. Unit III Lesson 7
The Long-Run Economy
Here we explore the LRAS and it’s relationship with the economy’s PPC
Factors that will shift he LRAS curve to the right
Productivity of labor (education)
Increases in technology (research & development expenditures)
Increases in capital stock of the economy (low, stable interest rates)

31. Explain and Illustrate Visual 3.14
Unit III Lesson 7
Explain and Illustrate Visual 3.14

32. Complete Activity 29 and review answers
Unit III Lesson 7
Complete Activity 29 and review answers

33. Fiscal Policy Two primary fiscal policy tools Government spending
Unit III Lesson 8
Fiscal Policy
Two primary fiscal policy tools
Government spending
Taxes

34. Government Spending Unit III Lesson 8
Gov’t spending affects the economy directly by increasing the demand for goods and services
As soon as the gov’t increases its spending, it initiates a multiplier process that results in a greater increase in total spending than the initial increase in gov’t spending
The increase in gov’t spending increases aggregate demand, shifting the AD curve to the right
In the short run, the usual effects are an increase in real GDP and the price level

35. Unit III Lesson 8
Taxes
Changes in taxes do not directly change real GDP
Changes in taxes affect the disposable income of households or businesses
These changes are felt through consumption and investment spending
An increase in taxes decreases disposable income, a decrease in disposable income decrease consumption, but by less than the increase in taxes
Some of the additional tax bill is paid from savings

36. Complete Activity 30 and review answers
Unit III Lesson 8
Complete Activity 30 and review answers

37. Automatic Stabilizers
Unit III Lesson 8
Automatic Stabilizers
Tools in the economy that respond to different phases of the business cycle
They are automatic, because they adjust without an action by Congress or the president
They serve as stabilizers because they limit the increase in real GDP during expansions and reduce the decrease in real GDP during a recession

38. Unit III Lesson 8
Income tax system
As an individual’s nominal income increases, he or she moves into higher tax brackets and pays more taxes, thus limiting the increase in disposable income and consumption

39. Unemployment compensation
Unit III Lesson 8
Unemployment compensation
As the economy slows and unemployment increases, the income of the unemployed does not fall to zero, which would leave a significant negative effect on the economy
Unemployment compensation provides a base level of income, and the negative impact on real GDP is lessened

40. Unit III Lesson 8
Stock and Bond returns
Many corporations establish the dividends they pay on shares of stock and maintain this payout for several years. Thus dividends do not follow the swings of the business cycle
Bond payments are established at the time the bond is issued and remain throughout the life of the bond

41. Complete Activity 31 and review answers
Unit III Lesson 8
Complete Activity 31 and review answers

42. Complete Activity 32 and review answers
Unit III Lesson 8
Complete Activity 32 and review answers

43. Complete Activity 33 and review answers
Unit III Lesson 8
Complete Activity 33 and review answers

44. REVIEW FOR UNIT III EXAM