Aggregate Demand Unit 3

February 12, 2016

Aggregate Demand is the demand by consumers, businesses, government, and foreign countries.

Why is AD downward sloping?

1.Real balance effect-      

•   higher price levels reduce the purchasing power of money     
•    This decreases the quantity of expenditures        
•  Lower price levels increase purchasing power and increase expenditures
• EX. if the balance in your bank was 50,000 but the inflation erodes your purchasing power your will

2.Interest rate effect-   

•     when the price level increases, lenders need to charge higherinterest rates to get a REAL return on their loans     
•  Higher interest rates discourage consumer spending and business investment

3.Foreign trade effect-        •       when U.S. price level rises foreign buyers purchase fewer U.S. goods and Americans buy more foreign goods        •       Exports fall and imports rose causing real GDP demanded to fall.(Xn decreases)Ex. If prices triple in the USA, Canada will no longer buy us goodscausing quantity demanded of us products to fall.

Shifters of Aggregate demand

GDP= C + I + G + Xn

2 parts to shift in AD (aggregate demand)        1.      • A change in C, Ig, G, and or Xn        2.      • A multiplier effect that produces a greater change than the original change in the 4 components

        •       increase in AD = (right shift)        •       Decrease in AD = ( left shift)

Determinates of AD:Household spending is effected by: - Consumer wealth        •       more wealth = more spending (AD ➡️)        •       Less wealth= less spending (AD⬅️)-Consumer expectations        •       positive expectations= more spending ➡️        •       Negative expectations= less spending ⬅️-Household indent was        •       less debt= more spending ➡️        •       More debt = less spending⬅️-Taxes        •       less taxes = more spending ➡️        •       Mores taxes = less spending ⬅️

Gross Private Investment•Investment spending is sensitive to:-The real interest rate        •       lower real interest rate= more investment ad➡️        •       Higher real interest rate= less investment ad⬅️-Expected returns        •       higher expected returns= more investment ad➡️        •       Lower expected returns = less investment ad⬅️        •       Expected returns are influenced by        ⁃       expectations of future profitability        ⁃       Technology        ⁃       Degree of excess capacity (existing stock of capital)        ⁃       Business taxes
Government spending        •       more gov spending ad➡️        •       Less gov spending ad⬅️
Net exports•net exports are sensitive to:
        ⁃       exchange rates (international value of $)        •       strong$ =more imports and fewer exports ad⬅️        •       Week $ = fewer imports and more exports ad➡️
        ⁃       relative income        •       strong foreign economies = more exports ad ➡️        •       Weak foreign economies = less exports as ⬅️

February 18, 2016

Aggregate supply

: level of real GDP that firms will produce at each price level (PL) 

Long run : 

• period of time where I put prices are completely flexible and the adjust to changes in the price level
• In the long run the level of Real GDP supplied is independent of the price-level

Short run: 

• period of time where I put prices are sticky and do not adjust to changes in the price level 
• in the short run the level of real GDP supplied is directly related to the price level

The long run aggregate supply (LRAS):  marks the level of full employment in the economy (analogous to PPC) 

• because Input prices are completely flexible in the long run, changes in price level do not change firms' real profits and therefore do not change firms' level of output. 
• This means that the LRAS is vertical at the economy's level of full employment 

Changes in SRAS: 

• increase inSRAS is seen as a shift to the right. SRAS➡️
• Decrease in SRAS seen as shift to the left ⬅️
• The key to understanding shifts is SRAS is per unit cost of production 
• Per unit production cost= (total output

Determinate a of SRAS: (effect unit production cost) 

• input prices

• domestic resource prices: wages (75% of al business costs), cost of capital, Raw materials (commonly priced) 
• Foreign resource prices
• Market power
• increase in resource prices SRAS ⬅️
• Decrease in resource prices SRAS ➡️

• Productivity (total output/ total input) 

• More productivity = lower unit production cost = SRAS➡️
• Lower productivity = higher unit production cost = SRAS⬅️ 

• Legal- institutional environment 

• taxes and subsidies: 
• • taxes ($ to gov) on business increase per unit production cost = SRAS⬅️
• • subsidies ($ from gov) to business to reduce per unit production cost SRAS ➡️

Government regulation 

• gov reg creates a cost of compliance SR️AS ⬅️
•  Deregulation reduces compliance costs  SRAS ➡️

Productivity            =  total input  

                                  total output 

February 19, 2016

full employment equilibrium : exists where AD Interscets SRAS & LRAS at the same point 

Recessionary gap: exists when equilibrium occurs below full employment output 

Inflationary Gap: exists when equilibrium occurs beyond full employment output