CHAPTER 12 AGGREGATE DEMAND SUPPLY Circular Flow economic

CHAPTER 12 AGGREGATE DEMAND SUPPLY

� Circular Flow – economic model showing income and product movements � Product markets � Goods and services � Total value of output � Factor (input or resource) markets � Resources � Factor payments = Income wages � rent � interest � profits �

� Expenditures: GDP = C + I + G + Xn � C = consumer spending = f(income, interest rates) � � � I = Business spending on plant and equipment (Investment) = f(interest rates, expected profits): Saving is necessary � � � Expectations of sales and profits Technology Business taxes Government sector (G): Government spending on public goods = f(votes) Foreign sector: Net Exports (Xn) = Exports (X) – Imports (Im)= f(exchange rates) � � Taxes (T) Consumer confidence Exchange rates: rate at which two currencies trade Exports: goods purchased buy foreigners Imports: goods we purchase from foreigners Income: GDP = C + S + T

� Aggregate Demand – total dollar value of all planned expenditures � AD Curve – inverse relationship between the price level (GDP Price Deflator) and total quantity demanded � Shifts � Components � Money Supply

� Aggregate Supply – Real domestic output offered for sale by producers � � AS Curve - positive relationship between the price level (GDP Price Deflator) and total quantity Shifts � � Resource prices Productivity � � � Legislation � � War – security costs OPEC Oil price increases 911 Internal shocks � � � Regulations External shocks – come from outside the borders � � Technology Education Weather and natural disasters Labor unions go on strike Population � � Immigration Age

� Equilibrium: Total quantity demanded = Total quantity supplied � Intersection of AD and AS

� Natural (Potential) Real GDP: Economy is healthy � Full employment � Anticipated inflation � 80 % Capacity

� Gaps � Contractionary Gap: Actual GDP < Natural (Potential) GDP � Sluggish economy � Unemployment � Could lead to a recession or depression � Expansionary GDP � Overheating Gap: Actual GDP > Natural (Potential) economy � Overemployment � Could lead to inflation