http www bized ac uk Aggregate Demand Supply

http: //www. bized. ac. uk Aggregate Demand (AD) Copyright 2005 – Biz/ed

http: //www. bized. ac. uk Aggregate Demand • The sum of all expenditure in the economy over a period of time • Macro concept – WHOLE economy • Formula: AD = C+I+G+(X-M) – C= Consumption Spending – I = Investment Spending – G = Government Spending – (X-M) = difference between spending on imports and receipts from exports (Balance of Payments) Copyright 2005 – Biz/ed

http: //www. bized. ac. uk Aggregate Demand Curve • Shows the overall level of

http: //www. bized. ac. uk Aggregate Demand Curve • Why does it slope down from left to right? – Assume RBNZ sets short term interest rates – Assume a rise in the price level will be met by a rise in interest rates – Any increase in interest rates will raise the cost of borrowing: • Consumption spending (C) will fall • Investment (I) will fall • International competitiveness will decrease because $NZ will appreciate– exports fall, imports rise • Therefore – a rise in the price level leads to lower levels of aggregate demand Copyright 2005 – Biz/ed

http: //www. bized. ac. uk Aggregate Demand Curve • The AD diagram: • Price Level on the vertical axis – assume an initial ‘target rate’ of P 1 (as measured by the CPI) • Real GDP or Real National Income or Real Output on the vertical axis (shown by the initial Y) Copyright 2005 – Biz/ed

http: //www. bized. ac. uk Aggregate Demand Curve Price Level Thethe This At lower level higher of level output Price of At the price level will Level National beofassociated P 2, Income rising P 1, the AD curve with interest requires a particular rates fewer mean units gives a Ilevel of level that of labour C, of and – (X-M) output Y 1 rises all unemployment haveof negative which effects to 7% we shown on will AD by call – NY UU= = 5% falls 7% to Y 2 P 1 AD Y 2 U = 7% Y 1 U = 5% Real National Income Copyright 2005 – Biz/ed

http: //www. bized. ac. uk Price Level Shifts in the Aggregate Demand Curve This would cause a Any exogenous Shifts in national AD will be rise in factor causingin. C, caused by changes income (economic factors C, I, or. G and I oraffecting G to rise, growth) and lead to a (X-M) factors) a (exogenous trade surplus fallincreasing in unemployment e. g. income causes a shift to tax (U =affect 2%)consumption (and vice rates the right in AD versa) P 1 AD 2 AD Y 1 U = 5% Y 2 U = 2% Real National Income Copyright 2005 – Biz/ed

http: //www. bized. ac. uk Consumption Expenditure • Exogenous factors affecting consumption: – Tax rates – Incomes – short term and expected income over lifetime – Wage increases – Availability of credit – Interest rates – Wealth • Property • Shares • Savings • Bonds Copyright 2005 – Biz/ed

http: //www. bized. ac. uk Investment Expenditure • Spending on: – – Machinery Equipment Buildings Infrastructure • Influenced by: – – Expected return on investment Interest rates Business confidence (expected future revenues) Expected inflation rates (inflationary expectations) Copyright 2005 – Biz/ed

http: //www. bized. ac. uk Government Spending • • • Defence (Army, Navy, etc)

http: //www. bized. ac. uk Import Spending (negative) • Goods and services bought from

http: //www. bized. ac. uk Export Earnings (Positive) • Goods and services sold abroad

http: //www. bized. ac. uk Aggregate Supply (AS) Copyright 2005 – Biz/ed

http: //www. bized. ac. uk Capacity of the Economy • • Costs of Production

http: //www. bized. ac. uk Price Level Aggregate Supply AS Economy starts to overheat Y 1 Yf Between Y 1 and‘Full Yf, Yf represents The An output shape of theof. AS Y 1 This shape increases in level capacity are Employment Output’ – curve would is suggest important the in possible but nearer reflects athe at this point the economy to Yf, determining economy is gets working the Keynesian view economy is working the more problems areto outcome below full in capacity the ofcapacity the ASwith curve. full and experienced economy and there would be cannot any acquiringproduce resources to widespread boost production more. unemployment. (production bottlenecks) especially labour skills shortages. Real National Income Copyright 2005 – Biz/ed

http: //www. bized. ac. uk Price Level Aggregate Supply AS 1 AS 2 Increases in capacity can occur as a result of a shift in AS (akin to a shift outwards of the Production Possibility Frontier) (PPF) Yf 1 Yf 2 Real National Income Copyright 2005 – Biz/ed

http: //www. bized. ac. uk Putting AD and AS together in this the situation, AD curve to the. AD 1 AS A shift. In Price Level as a result economy of a change would be in any or all of operating the factors at less affecting than AD would capacity, increase there growth, would reducebe unemployment but and at a cost the of higher economy inflation might(abe trade-off) growing only slowly. P 2 P 1 AD Y 1 Y 2 Yf Real National Income Copyright 2005 – Biz/ed

http: //www. bized. ac. uk Putting AD and AS together AS Further increases in AD would Price Level lead to successively smaller increases in growth and employment at the cost of ever higher inflation. P 3 AD 2 P 1 AD Y 1 Y 2 Yf Y 3 Real National Income Copyright 2005 – Biz/ed

http: //www. bized. ac. uk Sustained Growth Price Level AS AS 1 Sustained growth (not to be confused with sustainable economic growth) occurs when AS and AD rise at similar rates – national income can rise without effects on inflation P 1 AD 2 AD Y 1 Y 2 Real National Income Copyright 2005 – Biz/ed