Chapter 12 Aggregate Demand Aggregate Supply Copyright 2015

Chapter 12 Aggregate Demand Aggregate Supply Copyright © 2015 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.

Aggregate Demand • Real GDP desired at each price level • Inverse relationship • Real balances effect • Interest effect • Foreign purchases effect LO 1 12 -2

Price level Aggregate Demand AD 0 LO 1 Real domestic output, GDP 12 -3

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 LO 2 12 -4

Price level Changes in Aggregate Demand AD 2 0 AD 3 AD 1 Real domestic output, GDP LO 2 12 -5

Consumer Spending • • LO 2 Consumer wealth Household borrowing Consumer expectations Personal taxes 12 -6

Investment Spending • Real interest rates • Expected returns • Expectations about future business conditions • Technology • Degree of excess capacity • Business taxes LO 2 12 -7

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 LO 2 12 -8

Net Export Spending • National income abroad • Exchange rates • Dollar depreciation • Dollar appreciation LO 2 12 -9

Aggregate Supply • Total real output produced at each price level • Relationship depends on time horizon • Immediate short run • Short run • Long run LO 3 12 -10

AS: Immediate Short Run Price level Immediate-short-run aggregate supply P 1 0 ASISR Qf Real domestic output, GDP LO 3 12 -11

Aggregate Supply: Short Run AS Price level Aggregate supply (short run) 0 Qf Real domestic output, GDP LO 3 12 -12

Aggregate Supply: Long Run Price level ASLR Long-run aggregate supply 0 Qf Real domestic output, GDP LO 3 12 -13

Changes in Aggregate Supply • Determinants of aggregate supply • Shift factors • Collectively position the AS curve • Changes raise or lower per-unit production costs LO 4 12 -14

Changes in Aggregate Supply AS 3 AS 1 Price level AS 2 0 Real domestic output, GDP LO 4 12 -15

Input Prices • Domestic resource prices • Labor • Capital • Land • Prices of imported resources • Imported oil • Exchange rates LO 4 12 -16

Productivity • Real output per unit of input • Increases in productivity reduce costs • Decreases in productivity increase costs Productivity = Per-unit production cost LO 4 total output total inputs = total input cost total output 12 -17

Legal-Institutional Environment • Legal changes alter per-unit costs of output • Taxes and subsidies • Extent of government regulation LO 4 12 -18

Price level (index numbers) Equilibrium AS 100 a 92 b Real Output Demanded (Billions) Price Level (Index Number) Real Output Supplied (Billions) $506 108 $513 508 104 512 510 100 512 96 507 514 92 502 AD 0 502 510 514 Real domestic output, GDP (billions of dollars) LO 5 12 -19

Changes in Equilibrium Price level AS P 2 P 1 AD 2 AD 1 0 Qf Q 1 Q 2 Real domestic output, GDP LO 6 12 -20

Decreases in AD: Recession Price level AS P 1 P 2 b a c AD 1 AD 2 0 LO 6 Q 1 Q 2 Qf Real domestic output, GDP 12 -21

Decreases in AD: Recession • Prices are downwardly inflexible • Fear of price wars • Menu costs • Wage contracts • Efficiency wages • Minimum wage law LO 6 12 -22

Decreases in AS: Cost-Push Inflation Price level AS 2 P 1 AS 1 b a AD 0 LO 6 Q 1 Qf Real domestic output, GDP 12 -23

Increases in AS: Full-Employment Price level AS 1 P 3 P 2 P 1 AS 2 b a c AD 2 AD 1 0 Q 1 Q 2 Q 3 Real domestic output, GDP LO 6 12 -24

Stimulus and the Great Recession • Housing collapse triggers bank failures which leads to recession • Federal Reserve intervenes • Lowers short-term interest rates • Federal Government begins largest peacetime program of spending 12 -25

Stimulus and the Great Recession • • • GDP growth has been disappointing High debt load due to low interest rates High rate of savings Unequal impact Price increases rather than output gains 12 -26