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Aggregate Demand and Aggregate Supply
29
McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
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Aggregate Demand
• Real GDP desired at each price level• Inverse relationship
• Real balances effect
• Interest effect
• Foreign purchases effect
LO1 29-2
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Aggregate Demand
Real domestic output, GDP
Pri
ce l
evel
AD
LO1
0
29-3
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Changes in Aggregate Demand
• Determinants of aggregate demand
• Shift factors affecting C, I, G, Xn
• 2 components involved
• Change in one of the determinants
• Multiplier effect
LO1 29-4
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Changes in Aggregate Demand
Real domestic output, GDP
Pri
ce l
evel
AD1AD3
AD2
LO1
0
29-5
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Consumer Spending
• Consumer wealth• Household borrowing• Consumer expectations• Personal taxes
LO1 29-6
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Investment Spending
• Real interest rates• Expected returns
• Expectations about future business conditions
• Technology
• Degree of excess capacity
• Business taxes
LO1 29-7
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Government Spending
• Government spending increases
• Aggregate demand increases (as long as interest rates and tax rates do not change)
• More transportation projects• Government spending decreases
• Aggregate demand decreases
• Less military spending
LO1 29-8
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Net Export Spending
• National income abroad• Exchange rates
• Dollar depreciation
• Dollar appreciation
LO1 29-9
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Aggregate Supply
• Total real output produced at each price level
• Relationship depends on time horizon
• Immediate short run
• Short run
• Long run
LO2 29-10
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AS: Immediate Short Run
Real domestic output, GDP
Pri
ce l
evel
ASISR
Qf
Immediate-short-runaggregate supply
P1
0
LO2 29-11
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Aggregate Supply: Short Run
Real domestic output, GDP
Pri
ce l
evel
0 Qf
AS
Aggregate supply(short run)
LO2 29-12
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Aggregate Supply: Long Run
Real domestic output, GDP
Pri
ce l
evel
ASLR
Qf0
Long-runaggregatesupply
LO2 29-13
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Changes in Aggregate Supply
• Determinants of aggregate supply
• Shift factors• Collectively position the AS curve• Changes raise or lower per-unit
production costs
LO2 29-14
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Changes in Aggregate Supply
Real domestic output, GDP
Pri
ce l
evel
AS1
AS3
AS2
0
LO2 29-15
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Input Prices
• Domestic resource prices
• Labor
• Capital
• Land• Prices of imported resources
• Imported oil
• Exchange rates
LO2 29-16
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Productivity
• Real output per unit of input
• Increases in productivity reduce costs
• Decreases in productivity increase costs
LO2
Per-unit production cost =total input cost
total output
Productivity =total output
total inputs
29-17
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Legal-Institutional Environment
• Legal changes alter per-unit costs of output
• Taxes and subsidies
• Extent of government regulation
LO2 29-18
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Equilibrium
Real domestic output, GDP(billions of dollars)
Pri
ce le
vel (
ind
ex n
um
ber
s)
100
92
502 510 514
ab
AD
ASReal Output Demanded(Billions)
Price Level(Index Number)
Real OutputSupplied(Billions)
$506 108 $513
508 104 512
510 100 510
512 96 507
514 92 502
0
LO3 29-19
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AD Increases: Demand-Pull Inflation
Real domestic output, GDP
Pri
ce le
vel
AD1
AS
P1
P2
Q2Q1Qf
AD2
0
LO4 29-20
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Decreases in AD: Recession
Real domestic output, GDP
Pri
ce le
vel
AD1
AS
P1
P2
Q1 Q2 Qf
AD2
c
ab
0
LO4 29-21
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Decreases in AD: Recession
• Prices are downwardly inflexible
• Fear of price wars
• Menu costs
• Wage contracts
• Efficiency wages
• Minimum wage law
LO4 29-22
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Decreases in AS: Cost-Push Inflation
Real domestic output, GDP
Pri
ce le
vel
AD
AS1
P1
P2
Q1 Qf
AS2
a
b
0
LO4 29-23
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Increases in AS: Full-Employment
Real domestic output, GDP
Pri
ce le
vel
AD1
AS2
P1
P2
Q2Q1
AS1
b
AD2
c
P3
Q3
a
0
LO4 29-24
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Impact of Oil Prices Diminished?
• 1970’s
• Reduced AS and negative GDP gap
• Cost-push inflation
• Rising unemployment• 2000’s
• Core inflation steady
• Use 50% less oil and gas today
• Federal Reserve more vigilant
29-25