CHAPTERAggregate Demand and13Aggregate Supply AnalysisChapterOutlineandLearningObjectives13.1AggregateDemand13.2AggregateSupply13.3MacroeconomicEguilibriumin theLongRunand theShortRun13.4ADynamicAggregateDemandandAggregateSupplyModelAppendix:MacroeconomicSchools of Thought
1 Chapter Outline and Learning Objectives 13.1 Aggregate Demand 13.2 Aggregate Supply 13.3 Macroeconomic Equilibrium in the Long Run and the Short Run 13.4 A Dynamic Aggregate Demand and Aggregate Supply Model Appendix: Macroeconomic Schools of Thought CHAPTER 13 CHAPTER Aggregate Demand and Aggregate Supply Analysis
AggregateDemandandAggregate Supply ModelWehave now modeled long-run economic growth and also how realGDP is determine in the short run.Our new goal is to extend the model of the economy in the short run.By doing so, we will be able to understand why real GDP, the level ofemployment, and the price level fluctuate.: Our tool for doing this will be the aggregate demand andaggregate supply model; to build it up, we must determine howaggregate demand and aggregate supply are each formed.Aggregate demand and aggregate supply model: A model thatexplains short-run fluctuations in real GDP and the price level.2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 2 Aggregate Demand and Aggregate Supply Model We have now modeled long-run economic growth and also how real GDP is determine in the short run. Our new goal is to extend the model of the economy in the short run. By doing so, we will be able to understand why real GDP, the level of employment, and the price level fluctuate. • Our tool for doing this will be the aggregate demand and aggregate supply model; to build it up, we must determine how aggregate demand and aggregate supply are each formed. Aggregate demand and aggregate supply model: A model that explains short-run fluctuations in real GDP and the price level
ASneakPeekattheModelIn the short run, real GDP andPrice levelShort-run(GDPdeflator,the price level are determinedaggregate2009=100)supply,SRASby the intersection of theaggregate demand (AD)110curve...Aggregate demand (AD)curve: A curve that shows therelationship betweenthepriceAggregatedemand,ADlevel and the quantity of real0$17.0RealGDPGDP demanded by(trillions of2009 dollars)households, firms, and theFigure 13.1Aggregate demandgovernment.andaggregate supply...and the short-run aggregate supply (As) curve.Short-run aggregate supply (As) curve: A curve that shows therelationship in the short run between the price level and the quantityof real GDP supplied by firms2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 3 A Sneak Peek at the Model In the short run, real GDP and the price level are determined by the intersection of the aggregate demand (AD) curve. Aggregate demand (AD) curve: A curve that shows the relationship between the price level and the quantity of real GDP demanded by households, firms, and the government. .and the short-run aggregate supply (AS) curve. Short-run aggregate supply (AS) curve: A curve that shows the relationship in the short run between the price level and the quantity of real GDP supplied by firms. Aggregate demand and aggregate supply Figure 13.1
AggregateDemand13.1LEARNINGOBJECTIVEIdentifythedeterminantsofaggregatedemandanddistinguishbetweenamovement alongtheaggregate demand curve and a shift of the curve.@2015PearsonEducation,lnc
LEARNING OBJECTIVE © 2015 Pearson Education, Inc. 4 Aggregate Demand 13.1 Identify the determinants of aggregate demand and distinguish between a movement along the aggregate demand curve and a shift of the curve
TheFourComponentsofReal GDPReal GDP has four components: consumption (C), investment ()government purchases (G), and net exports (NX):Y=C+I+G+NXGovernment purchases are generally determined by the decisions ofpolicymakers; but each of the others changes, depending on the pricelevel.Wewill examine each inturn.The wealth effect:howa change in theprice level affectsconsumption (C): Household consumption is most strongly determine by income, butit is also affected by wealth.Some household wealth is held in nominal assets; so as pricelevels rise,the real value of household wealthdeclines.Thisresults in less consumption.@2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 5 The Four Components of Real GDP Real GDP has four components: consumption (C), investment (I), government purchases (G), and net exports (NX): Y = C + I + G + NX Government purchases are generally determined by the decisions of policymakers; but each of the others changes, depending on the price level. We will examine each in turn. The wealth effect: how a change in the price level affects consumption (C) • Household consumption is most strongly determine by income, but it is also affected by wealth. • Some household wealth is held in nominal assets; so as price levels rise, the real value of household wealth declines. This results in less consumption
WhyistheADCurveDownward Sloping?The interest-rate effect:how a change in the price level affectsinvestment ().Whenpricesrise,householdsandfirmsneedmoremoneytofinance buying and selling.This increase in demand for money causes the“price" of holdingmoney (the interest rate) to rise, discouraging firm investmentThe international-trade effect: how a change in the price levelaffects net exports (NX): When U.S. price levels rise, U.S. exports become more expensiveandimportsbecomerelativelycheaper.Fewerexportsandmoreimports means netexports fallsEach effect moves in the same direction:an increase in thepriceleveldecreases real GDP2015PearsonEducation,Inc.6
© 2015 Pearson Education, Inc. 6 Why is the AD Curve Downward Sloping? The interest-rate effect: how a change in the price level affects investment (I) • When prices rise, households and firms need more money to finance buying and selling. • This increase in demand for money causes the “price” of holding money (the interest rate) to rise, discouraging firm investment. The international-trade effect: how a change in the price level affects net exports (NX) • When U.S. price levels rise, U.S. exports become more expensive and imports become relatively cheaper. Fewer exports and more imports means net exports falls. Each effect moves in the same direction: an increase in the price level decreases real GDP
Shifts of the AD Curvevs.Movements along ItPrice level(GDPdeflatorTheaggregatedemandcurve2009 = 100)shows the relationship110between the price level and105real GDP demanded, holdingeverything else constant.A change in thepricelevel not$17.0172RealGDP(trllions of 2009 dollars)caused by a component ofreal GDP changing results ina movement along the ADPrice level(GDPdeflatorcurve.2009=100)Achangeinsomecomponentof aggregate demand, on the105other hand, will shift the ADcurve.AD$16.917.2RealGDP(trillionsof2009dollars)2015PearsonEducation,lnc
© 2015 Pearson Education, Inc. 7 Shifts of the AD Curve vs. Movements along It The aggregate demand curve shows the relationship between the price level and real GDP demanded, holding everything else constant. A change in the price level not caused by a component of real GDP changing results in a movement along the AD curve. A change in some component of aggregate demand, on the other hand, will shift the AD curve
AD shifts:Changes in Monetary PolicyA government policy change could shift aggregate demand.Thereare two categories of government policies here:1. Monetary policy: The actions the Federal Reserve takes tomanagethemoneysupplyandinterestratestopursuemacroeconomicpolicyobjectivesIfthe Federal Reserve causes interest rates to rise,investmentspending will fall; if it causes interest rates to fall, investmentspending will rise.shifts the aggregateAnincreasein...because...demand curve..Priceinterestrateshigherinterestratesraisethelevelcosttofirmsandhouseholdsofborrowing,reducingconsumptionandinvestmentADspending.D0RealGDPTable13.1Variables that shift theaggregate demand curve2015PearsonEducation,Inc.8
© 2015 Pearson Education, Inc. 8 AD shifts: Changes in Monetary Policy A government policy change could shift aggregate demand. There are two categories of government policies here: 1. Monetary policy: The actions the Federal Reserve takes to manage the money supply and interest rates to pursue macroeconomic policy objectives. If the Federal Reserve causes interest rates to rise, investment spending will fall; if it causes interest rates to fall, investment spending will rise. Variables that shift the aggregate demand curve Table 13.1 shifts the aggregate An increase in. demand curve. because
ADshifts:ChangesinFiscalPolicy2.Fiscal policy: Changes in federal taxes and purchases that areintended to achieve macroeconomic policy objectives.Increasingordecreasingtaxesaffectsdisposableincome,andhenceconsumption. The government can also alter its level ofgovernmentpurchases.shifts the aggregateAn increase in..demand curve...because...Pricegovernment purchases areagovernmentpurchaseslevelcomponent of aggregatedemand.0RealGDPPriceconsumption spending fallspersonal incometaxeslevelwhen personaltaxesrise,andorbusinesstaxesinvestmentfallswhenbusinesstaxes rise.ADAD0Real GDPTable 13.1Variablesthatshifttheaggregatedemand curve9@2015Pearson Education,Inc
© 2015 Pearson Education, Inc. 9 AD shifts: Changes in Fiscal Policy 2. Fiscal policy: Changes in federal taxes and purchases that are intended to achieve macroeconomic policy objectives. Increasing or decreasing taxes affects disposable income, and hence consumption. The government can also alter its level of government purchases. Variables that shift the aggregate demand curve Table 13.1 shifts the aggregate An increase in. demand curve. because
AD Shifts:Changes inExpectationsHouseholds or firms could become more optimistic about the future,increasing consumption or investment respectivelyOf course, theopposite could also occur.shiftsthe aggregateAn increase in..demand curve..because...Pricehouseholds'expectationsconsumptionspendingleveloftheirfutureincomesincreases.ADAD0RealGDPPricefirmsexpectationsoftheinvestmentspending increaseslevelfutureprofitabilityofinvestment spendingAD,AD20RealGDPTable13.1Variables that shifttheaggregatedemandcurve10@2015PearsonEducation,Inc
© 2015 Pearson Education, Inc. 10 AD Shifts: Changes in Expectations Households or firms could become more optimistic about the future, increasing consumption or investment respectively. Of course, the opposite could also occur. Variables that shift the aggregate demand curve Table 13.1 shifts the aggregate An increase in. demand curve. because