Chapter 08 Aggregate Demand Aggregate Supply Mc GrawHillIrwin

Chapter Outline • Aggregate Demand • Aggregate Supply • Shifts in Aggregate Demand Aggregate

Aggregate Demand • Aggregate Demand: the amounts of real domestic output which domestic consumers,

Figure 1 Aggregate Demand PI AD RGDP Mc. Graw-Hill/Irwin © 2012 The Mc. Graw-Hill

Why Aggregate Demand is Downward Sloping • Real Balances Effect • Because higher prices

Aggregate Supply • Aggregate Supply: the level of real domestic output available at each

Figure 2 The Aggregate Supply Curve AS PI Classical Range Intermediate Range Keynesian Range

The Ranges of AS • Keynesian Range • Large amounts of unemployment make it

Variables that Shift Aggregate Demand • • • Taxes Interest Rates Confidence Strength of

Determinants of AD Variable Taxes GDP Component C, I, G, X C, I Interest

Figure 3 AD Increases PI AS PI’ PI* AD’ AD RGDP* Mc. Graw-Hill/Irwin RGDP’

Figure 4 AD Decreases PI AS PI* PI’ AD AD’ RGDP’ Mc. Graw-Hill/Irwin RGDP*

Variables that Shift AS • Input Prices • Productivity • Government Regulation Mc. Graw-Hill/Irwin

Determinants of AS Variable Input Prices Effect of an Increase on AS Decrease so

Figure 5 Increase in AS PI AS AS’ PI* PI’ AD RGDP* Mc. Graw-Hill/Irwin

Figure 6 Decrease in AS PI AS’ AS PI’ PI* AD RGDP’ Mc. Graw-Hill/Irwin

Causes of Inflation • Demand Pull Inflation: inflation caused by an increase in aggregate

Government Influence: Aggregate Demand • Government can influence economic activity with aggregate demand side

Government Influence: Aggregate Supply • Government can influence economic activity with aggregate supply side

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Chapter Outline • Aggregate Demand • Aggregate Supply • Shifts in Aggregate Demand Aggregate Supply • Causes of Inflation • Supply-Side Economics • How the Government Can Influence (but probably not control) the Economy Mc. Graw-Hill/Irwin © 2012 The Mc. Graw-Hill Companies, All Rights Reserved 8 -2 1 -2

Aggregate Demand • Aggregate Demand: the amounts of real domestic output which domestic consumers, businesses, governments, and foreign buyers collectively will desire to purchase at each possible price level Mc. Graw-Hill/Irwin © 2012 The Mc. Graw-Hill Companies, All Rights Reserved 8 -3 1 -3

Why Aggregate Demand is Downward Sloping • Real Balances Effect • Because higher prices reduce real spending power, prices and output are negatively related. • Foreign Purchases Effect • When domestic prices are high, we will export less to foreign buyers and we will import more from foreign producers. Therefore higher prices leads to less domestic output. • Interest Rate Effect • higher prices lead to inflation which leads to less borrowing and a lowering of RGDP Mc. Graw-Hill/Irwin © 2012 The Mc. Graw-Hill Companies, All Rights Reserved 8 -5 1 -5

The Ranges of AS • Keynesian Range • Large amounts of unemployment make it so that increases in aggregate demand have no affect on wages or prices. • Classical Range • Full employment makes it so that increases in aggregate demand only increase wages or prices. • Intermediate Range • Some sectors of the economy reach full employment more quickly than others. Mc. Graw-Hill/Irwin © 2012 The Mc. Graw-Hill Companies, All Rights Reserved 8 -8 1 -8

Variables that Shift Aggregate Demand • • • Taxes Interest Rates Confidence Strength of the Dollar Government Spending Mc. Graw-Hill/Irwin © 2012 The Mc. Graw-Hill Companies, All Rights Reserved 8 -9 1 -9

Determinants of AD Variable Taxes GDP Component C, I, G, X C, I Interest Rates C, I Confidence Strength of the Dollar Government Spending Effect of an increase on AD Decrease so AD <= C, I Increase so AD => X (exports- Decrease so imports) AD <= G Increase so AD => Mc. Graw-Hill/Irwin Effect of a decrease on AD Increase so AD => Decrease so AD <= © 2012 The Mc. Graw-Hill Companies, All Rights Reserved 8 -10 1 -10

Determinants of AS Variable Input Prices Effect of an Increase on AS Decrease so AS Productivity Increase so AS Government Decrease so Regulation AS Mc. Graw-Hill/Irwin Increase so AS Decrease so AS Increase so AS © 2012 The Mc. Graw-Hill Companies, All Rights Reserved 8 -14 1 -14

Causes of Inflation • Demand Pull Inflation: inflation caused by an increase in aggregate demand • Cost Push Inflation: inflation caused by a decrease in aggregate supply Mc. Graw-Hill/Irwin © 2012 The Mc. Graw-Hill Companies, All Rights Reserved 8 -17 1 -17

Government Influence: Aggregate Demand • Government can influence economic activity with aggregate demand side policies affecting: • Taxes • Government Spending • Interest Rates Mc. Graw-Hill/Irwin © 2012 The Mc. Graw-Hill Companies, All Rights Reserved 8 -18 1 -18

Government Influence: Aggregate Supply • Government can influence economic activity with aggregate supply side policies affecting • input costs (labor and wage) • reducing regulation • Increase incentives to • Work • Take Risks • The actions are call Supply Side Economics Mc. Graw-Hill/Irwin © 2012 The Mc. Graw-Hill Companies, All Rights Reserved 8 -19 1 -19