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

2. Shifters of Aggregate Demand Change in C onsumer Spending Change in I nvestment Spending Change in G overnment Spending Net E X port Spending AD = C + I + G + X Shifters of Aggregate Supply AS = I + R + A + P Change in R esource Prices Change in A ctions of the Government Change in P roductivity (Investment) 2 Change in I nflationary Expectations

3. Practice 3

4. B A D A D B A A C A major increase in productivity. A Answer and identify shifter: C.I.G.X or I.R.A.P 4

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

6. Inflationary and Recessionary Gaps 6

7. Price Level 7 AD AS Example: Assume the government increases spending. What happens to PL and Output? GDP R LRAS QYQY AD 1 PL e PL 1 Q1Q1 PL and Q will Increase

8. Price Level 8 AS Inflationary Gap GDP R LRAS QYQY AD 1 PL 1 Q1Q1 Output is high and unemployment is less than NRU Actual GDP above potential GDP

9. Price Level 9 AD AS GDP R QYQY PL e PL 1 Q1Q1 LRAS AS 1 Stagflation Stagnate Economy + Inflation Example: Assume the price of oil increases drastically. What happens to PL and Output?

10. Price Level 10 AD GDP R QYQY PL 1 Q1Q1 LRAS AS 1 Recessionary Gap Output low and unemployment is more than NRU Actual GDP below potential GDP

11. AD and AS Practice Worksheet 11

12. How does this cartoon relate to Aggregate Demand? 12

13. Price Level GDP R AS AD=C+I+G+X P2P2 P1P1 AD 2 Q f (Y*or FE) LRAS Q2Q2 Draw AD and AS at full employment Output IncreasesPL Increases 13

14. Short Run and Long Run 14

15. Price Level 15 AD AS Shifts in AD or AS change the price level and output in the short run GDP R QYQY PL e LRAS

16. Price Level 16 AD AS Example: Assume consumers increase spending. What happens to PL and Output? GDP R LRAS QYQY AD 1 PL e PL 1 Q1Q1

17. Price Level 17 AD AS Now, what will happen in the LONG RUN? GDP R QYQY AD 1 PL e PL 1 Q1Q1 LRAS Inflation means workers seek higher wages and production costs increase AS 1 PL 2 Back to full employment with higher price level

18. Price Level 18 AD AS Example: Consumer expectations fall and consumer spending plummets. What happens to PL and Output in the Short Run and Long Run? GDP R LRAS QYQY AD AD 1 PL 1 Q1Q1 AS 1 PL 2 PL e AS increases as workers accept lower wages and production costs fall

19. The Ratchet Effect A ratchet (socket wrench) permits one to crank a tool forward but not backward. tool forward but not backward. 19

20. Does deflation (falling prices) often occur? Not as often as inflation. Why? If prices were to fall, the cost of resources must fall or firms would go out of business. The cost of resources (especially labor) rarely fall because: Labor Contracts (Unions) Wage decrease results in poor worker morale. Firms must pay to change prices (ex: re- pricing items in inventory, advertising new prices to consumers, etc.) Like a ratchet, prices can easily move up but not down! 20