9 000 8 000 The orange line shows

  • Slides: 22
Download presentation
9, 000 8, 000 The orange line shows fullemployment or potential output. 7, 000

9, 000 8, 000 The orange line shows fullemployment or potential output. 7, 000 6, 000 The green line shows actual output. During recessions, output declines. 5, 000 4, 000 During expansions, output rises—sometimes rapidly. 3, 000 20 03 19 95 19 90 19 85 19 80 19 75 19 70 19 65 2, 000 19 60 Actual and Potential Real GDP (Billions of 1996 Dollars) Figure 1 a: Potential and Actual Real GDP, 1960 -2001 1

Figure 1: The Two-Way Relationship Between Output and the Price Level Aggregate Demand Curve

Figure 1: The Two-Way Relationship Between Output and the Price Level Aggregate Demand Curve Price Level Real GDP Aggregate Supply Curve 2

Figure 2 a: Deriving the Aggregate Demand Curve (a) Interest Rate 9% 6% Ms

Figure 2 a: Deriving the Aggregate Demand Curve (a) Interest Rate 9% 6% Ms H As the price level rises, money demand increases and interest rate rises. E 500 Money ($ Billions) 3

Figure 2 b/c: Deriving the Aggregate Demand Curve (c) Aggregate Expenditure ($ Trillions) (b)

Figure 2 b/c: Deriving the Aggregate Demand Curve (c) Aggregate Expenditure ($ Trillions) (b) E The rise in the interest rate causes real GDP to fall. H 6 AEr = 6% AEr = 9% 10 Real GDP ($ Trillions) Price Level 140 H 100 On the AD curve, a higher price level is associated with a lower real GDP. E AD 6 10 Real GDP ($ Trillions) 4

Figure 3: A Spending Shock Shifts the AD Curve Real Aggregate Expenditure ($ Trillions)

Figure 3: A Spending Shock Shifts the AD Curve Real Aggregate Expenditure ($ Trillions) (a) (b) At any given price level, an increase in government purchases shifts the AE line upward, raising real GDP. H Since real GDP is higher at the given price level, the AD curve shifts rightward. Price Level AE 2 AE 1 100 E H E 10 13. 5 AD 1 AD 2 Real GDP ($ Trillions) 10 13. 5 Real GDP ($ Trillions) 5

Figure 4 a: Effects of Key Changes on the Aggregate Demand Curve (a) Price

Figure 4 a: Effects of Key Changes on the Aggregate Demand Curve (a) Price Level Price level ↑ moves us leftward along the AD curve P 3 Price level ↓ moves us rightward along the AD curve P 1 P 2 AD Q 3 Q 1 Q 2 Real GDP 6

Figure 4 b: Effects of Key Changes on the Aggregate Demand Curve (b) Price

Figure 4 b: Effects of Key Changes on the Aggregate Demand Curve (b) Price Level Entire AD curve shifts rightward if: • a, IP, G, or NX increases • Net taxes decrease • The money supply increases AD 2 AD 1 Real GDP 7

Figure 4 c: Effects of Key Changes on the Aggregate Demand Curve (c) Price

Figure 4 c: Effects of Key Changes on the Aggregate Demand Curve (c) Price Level decreases Entire AD curve shifts leftward if: • a, IP, G, or NX decreases • Net taxes increase • The money supply decreases AD 1 AD 2 Real GDP 8

Figure 5: The Aggregate Supply Curve Price Level AS 130 B 100 80 A

Figure 5: The Aggregate Supply Curve Price Level AS 130 B 100 80 A Starting at point A, an increase in output raises unit costs. Firms raise prices, and the overall price level rises. C Starting at point A, a decrease in output lowers unit costs. Firms cut prices, and the overall price level falls. 6 10 13. 5 Real GDP ($ Trillions) 9

Movements Along the AS Curve o When a change in output causes price level

Movements Along the AS Curve o When a change in output causes price level to change, we move along economy’s AS curve n n What happens in economy as we make such a move? As we move upward along AS curve, we can represent what happens as follows 10

Figure 6: Shifts of the Aggregate Supply Curve AS 2 Price Level 140 100

Figure 6: Shifts of the Aggregate Supply Curve AS 2 Price Level 140 100 AS 1 L A 10 When unit costs rise at any given real GDP, the AS curve shifts upward–e. g. , an increase in world oil prices or bad weather for farm production. Real GDP ($ Trillions) 11

Figure 7 a: Effects of Key Changes on the Aggregate Supply Curve (a) Price

Figure 7 a: Effects of Key Changes on the Aggregate Supply Curve (a) Price Level AS Real GDP ↑ moves us rightward along the AS curve P 3 Real GDP ↓ moves us leftward along the AS curve P 1 P 2 Q 1 Q 3 Real GDP 12

Figure 7 b: Effects of Key Changes on the Aggregate Supply Curve (b) Price

Figure 7 b: Effects of Key Changes on the Aggregate Supply Curve (b) Price Level AS 2 AS 1 Entire AS curve shifts upward if unit costs ↑ for any reason besides an increase in real GDP Real GDP 13

Figure 7 c: Effects of Key Changes on the Aggregate Supply Curve (c) Price

Figure 7 c: Effects of Key Changes on the Aggregate Supply Curve (c) Price Level AS 1 AS 2 Entire AS curve shifts downward if unit costs ↓ for any reason besides an decrease in real GDP Real GDP 14

Figure 8: Short-Run Macroeconomic Equilibrium AS Price Level B 140 E 100 F AD

Figure 8: Short-Run Macroeconomic Equilibrium AS Price Level B 140 E 100 F AD 6 10 14 Real GDP ($ Trillions) 15

Figure 9: The Effect of a Demand Shock AS Price Level 130 115 100

Figure 9: The Effect of a Demand Shock AS Price Level 130 115 100 H J E AD 1 10 13. 5 12. 5 AD 2 Real GDP($ Trillions) 16

An Increase in Government Purchases o Can summarize impact of price-level changes n When

An Increase in Government Purchases o Can summarize impact of price-level changes n When government purchases increase, horizontal shift of AD curve measures how much real GDP would increase if price level remained constant o But because price level rises, real GDP rises by less than horizontal shift in AD curve 17

An Decrease in Government Purchases 18

An Decrease in Government Purchases 18

An Increase in the Money Supply o Although monetary policy stimulates economy through a

An Increase in the Money Supply o Although monetary policy stimulates economy through a different channel than fiscal policy n n Once we arrive at AD and AS diagram, two look very much alike Can represent situation as follows 19

Figure 10: The Long-Run Adjustment Process Price Level AS 2 AS 1 P 4

Figure 10: The Long-Run Adjustment Process Price Level AS 2 AS 1 P 4 K J P 3 P 2 P 1 H E AD 2 AD 1 YFE Y 3 Y 2 Real GDP 20

Demand Shocks: Adjusting to the Long Run o For a positive demand shock that

Demand Shocks: Adjusting to the Long Run o For a positive demand shock that shifts AD curve rightward, self-correcting mechanism works like this 21

Figure 11: Long-Run Adjustment After A Negative Demand Shock Price Level AS 1 AS

Figure 11: Long-Run Adjustment After A Negative Demand Shock Price Level AS 1 AS 2 P 1 P 2 N P 3 E M AD 1 AD 2 YFE Real GDP 22