slides created by kevin brady and eric chiang aggregate demand and supply interactive examples to...

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Kevin Brady and Eric Chiang

Aggregate Demand and Supply

Interactive Examples

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Material from this presentation can be found in:

Chapter 19

CoreEconomics, 2e

Begin


AggregatePrice Level

(P)

Aggregate Output (Y)

The aggregate demand (AD) and aggregate supply (AS) model is used to analyze the economy.

It shows the relationship between aggregate output of goods and services in the economy and the price level.

Back


Next



(P)


Back


The AD curve shows the output of goods and services demanded at different price levels.

AD

Question: Why is the AD curve negatively sloped?

Answer



(P)


Back


The AD curve shows the output of goods and services demanded at different price levels.

AD

Question: Why is the AD curve negatively sloped?

Answer: The three main reasons are the

1. wealth effect2. export effect3. interest rate effect

Next



(P)


Back


The determinants of aggregate demand are those factors that shift the entire aggregate demand curve when they change.

AD

Question: What are the determinants of aggregate demand?

Answer



(P)


Back


The determinants of aggregate demand are those factors that shift the entire aggregate demand curve when they change.

AD

Question: What are the determinants of aggregate demand?

Answer: They are the componentsof GDP.

1. Consumer Spending2. Investment3. Government Spending4. Net Exports

Next



(P)


Back


Question: If the stock market rises significantly during the next year, what would happen to the aggregate demand curve?

AD

Answer



(P)


Back


Question: If the stock market rises significantly during the next year, what would happen to the aggregate demand curve?

AD0

Next

Answer: The aggregate demand curve would shift to the right. If the stock market rises, consumers will be wealthier, and they are willing to buy more at each price level.

AD1

P0

Y0

Notice that at price level P0, aggregate output was Y0. After the increase in aggregate demand, aggregate output increases to Y1 at the price level P0.

Y1



(P)


Back


Question: Assume the graph to the right represents the U.S. economy. If foreign countries become richer, will this affect aggregate demand in the U.S.?

AD

Answer



(P)


Back


Question: Assume the graph to the right represents the U.S. economy. If foreign countries become richer, will this affect aggregate demand in the U.S.?

AD0

Next

Answer: Yes! The aggregate demand curve would shift to the right. If foreign consumers are richer, they will spend more. Part of this spending will be on U.S. exports. AD1



(P)


Back


Question: If the government decides to raise taxes in order to reduce the budget deficit, what would happen to the aggregate demand curve?

AD

Answer



(P)


Back


Question: If the government decides to raise taxes in order to reduce the budget deficit, what would happen to the aggregate demand curve?

Answer: The aggregate demand curve would shift to the left. Higher taxes will leave less money for consumers to spend at each price level.

AD0

AD1

Next



(P)


The aggregate supply curve shows the real GDP that firms will produce at varying price levels.

We will need to make a distinction between the short-run aggregate supply curve (SRAS) and the long-run aggregate supply curve (LRAS).

Back


Next



(P)


Let’s first begin with the SRAS curve.

Back


Question: Why is the SRAS curve positively sloped?

SRAS

Answer



(P)


Let’s first begin with the SRAS curve.

Back


Next

Question: Why is the SRAS curve positively sloped?

SRAS

Answer: The SRAS curve is positively sloped because some input costs are slow to change in the short run.

For example, when prices rise, wages for workers do not automatically adjust upward. The result is higher profits for businesses, which in turn induces them to supply more output.



(P)


The determinants of the short-run aggregate supply curve are those factors that shift the entire aggregate supply curve when they change.

Back


Question: What are the determinants of short-run aggregate supply?

SRAS

Answer



(P)


The determinants of the short-run aggregate supply curve are those factors that shift the entire aggregate supply curve when they change.

Back


Next

Question: What are the determinants of short-run aggregate supply?

SRAS

Answer: There are five maindeterminants.

1. Input Prices2. Productivity3. Taxes and Regulation4. Market Power of Firms5. Expectations



(P)


Back


Question: If a new technology were developed that could extract twice the amount of energy from each barrel of oil, what would happen to the SRAS curve?

Answer

SRAS0



(P)


Back


Question: If a new technology were developed that could extract twice the amount of energy from each barrel of oil, what would happen to the SRAS curve?

SRAS0

Answer: The SRAS curve would shift to the right. At each price level, suppliers would be willing to bring more goods to the market.

SRAS1

P0

Y0 Y1

Notice that at price level P0, aggregate output was Y0. After the increase in aggregate supply, aggregate output increases to Y1 at the price level P0.

Next



(P)


Back


Question: If businesses expect the prices for their products to rise in the near future, what would happen to the SRAS curve?

Answer

SRAS0



(P)


Back


Question: If businesses expect the prices for their products to rise in the near future, what would happen to the SRAS curve?

Answer: The SRAS curve would shift to the left. If companies think they can sell their products for more money in the near future, they will cut back on their current supply and wait to get better prices.

SRAS0

SRAS1

Next



(P)


Back


Question: If the President of the United States enacts tough new compliance laws for every company importing goods in order to minimize the risk of terrorist activity, would this affect the aggregate supply curve?

Answer

SRAS0



(P)


Back


Question: If the President of the United States enacts tough new compliance laws for every company importing goods in order to minimize the risk of terrorist activity, would this effect the aggregate supply curve?

SRAS0

Answer: Yes, the SRAS curve would shift to the left. The new compliance laws will raise the costs of supplying goods, and therefore producers will bring less product to market for each given price level.

SRAS1

Next



(P)


Let’s introduce the long-run aggregate supply curve (LRAS).

Back


Question: What is the time period cutoff between the short run and the long run?

Answer



(P)


Let’s introduce the long-run aggregate supply curve (LRAS).

Back


Question: What is the time period cutoff between the short run and the long run?

Answer: Trick question! In the current context, the difference between the short run and the long run has nothing to do with a time horizon. The difference is that in the short run prices are sticky and in the long run prices are flexible.

Next



(P)


Back


Question: Why is the LRAS curve a vertical line?

Answer

LRAS



(P)


Back


Question: Why is the LRAS curve a vertical line?

LRAS

Answer: The LRAS is vertical at full employment because the economy has reached its maximum capacity to produce.

Next



(P)


Back


Answer

LRASThe determinants of the long-run aggregate supply curve are those factors that shift the entire LRAS curve when they change.

Question: What are the determinants of the LRAS curve?



(P)


Back


LRASThe determinants of the long-run aggregate supply curve are those factors that shift the entire LRAS curve when they change.

Question: What are the determinants of the LRAS curve?

Answer: The determinants of the LRAS curve are

1. resources2. productivity3. technology

Next



(P)


Back


Question: If the largest earthquake ever recorded struck the economy and made it impossible to extract certain vital natural resources, what would happen to the LRAS curve?

Answer

LRAS



(P)


Back


Question: If the largest earthquake ever recorded struck the economy and made it impossible to extract certain vital natural resources, what would happen to the LRAS curve?

LRAS0

Answer: The LRAS curve would shift to the left because the productive capacity of the economy would be smaller.

LRAS1

Next



(P)


Back


Question: What effect did the invention of the internet have on the LRAS curve?

Answer

LRAS



(P)


Back


Question: What effect did the invention of the internet have on the LRAS curve?

LRAS0

Answer: The LRAS curve shifted to the right as a result of the invention of the internet. The new technology made workers more productive and opened the door to new industries, both of which increased the productive capacity of the economy.

LRAS1

Next



(P)


We are now ready to discuss the concept of macroeconomic equilibrium.

Back


Short-run macroeconomic equilibrium occurs at the intersection of the SRAS and AD curves.

Long-run macroeconomic equilibrium occurs at the intersection of the SRAS, AD, and LRAS curves.

SRAS

AD

LRAS

Next



(P)


Assume the economy is in long-run macroeconomic equilibrium at price level P0 and output level Y0.

Back


Answer

SRAS0

AD0

LRAS0

Question: If home prices across the economy rise, what will be the short-run and long-run effects in our model?

P0

Y0



(P)


Back


SRAS0

AD0

LRAS0

Question: If home prices across the economy rise, what will be the short-run and long-run effects in our model?

P0

Y0

Answer: An increase in home values increases wealth. In the short run, this causes the AD0 curve to shift to the right to AD1. Note that the price level and output level have increased to P1 and Y1, respectively.

Answer: In the long run, workers will feel the pressure of the increased prices and demand higher wages. This will cause the SRAS0 curve to shift to the left to SRAS1. Here a new equilibrium is reached at P2 and Y0.

AD1

SRAS1

Y1

P1

P2

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