Intro to Macroeconomics: Chapter 20- Aggregate Demand & Aggregate Supply
Intro to Macroeconomics: Chapter 20- Aggregate Demand & Aggregate Supply Econ 10233
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This 5 page Class Notes was uploaded by Rooshna Ali on Thursday April 21, 2016. The Class Notes belongs to Econ 10233 at Texas Christian University taught by Steven Ellis in Winter 2016. Since its upload, it has received 30 views. For similar materials see Intro Macroeconomics in Economcs at Texas Christian University.
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Date Created: 04/21/16
Chapter 20- Aggregate Demand and Aggregate Supply • Introduction o Over the long run, real GDP grows about 3% year on average o In the short run, GDP fluctuates around its trend. § Recessions: periods of falling real incomes and rising unemployment Also- negative real GDP for two consecutive quarters § Depressions: severe recessions (very rare) o Short-run economic fluctuations are often called business cycles • Three Facts About Economic Fluctuations 1. Economic fluctuations are irregular and unpredictable 2. Most macroeconomic quantiles fluctuate together 3. As output falls, unemployment rises • Classical economics— A Recap o Classical Dichotomy, the separation of variables into two groups: § Real – quantities, relative prices § Nominal – measured in terms of money o The neutrality of money: changes in the money supply affect nominal but NOT real variables o Most economists believe classical theory describes the world in the long run but not the short run o In the short run, changes in nominal (like the money supply or P) can affect real variables (like Y or the u-rate) • The Model of Aggregate Demand and Aggregate Supply o The model determines the equilibrium price level and equilibrium output (real GDP) • The Aggregate-Demand (AD) Curve o The AD curve shows the quantity of ALL goods & services demanded in the economy at ANY given price level • Why the AD Curve Slopes Downward Y = C + I + G + NX Assume G is fixed by govt. policy To understand the slope of AD, we must determine how a change in P affects C, I, and NX 1. The Wealth Effect (P and C) Suppose P rises Ø The dollars people hold buy fewer goods and services, so real wealth is lower (still have same amount of money though) Ø People feel poorer Result: C falls 2. The Interest-Rate Effect (P and I) Suppose P rises Ø Buying goods and services requires more dollars Ø To get these dollars, people sell bonds or other assets (price of bonds go up) Ø This drives up interest rates Result: I falls (recall I depends negatively on interest rates 2 3. The Exchange-Rate Effect (P and NX) Suppose P rises Ø U.S. interest rates rise (the interest-rate effect) Ø Foreign investors desire more U.S. bonds Ø Higher demand for money in foreign exchange market Ø U.S. exchange rate appreciates Ø U.S. exports more expensive to people abroad, imports cheaper to U.S. residents Result: NX falls • Why the AD Curve Might Shift o Any event that changes C, I, G, or NX –except a change in P— will shift the AD curve o Changes in C § Stock market boom/crash § Preferences re: consumption/saving tradeoff § Tax hikes/cuts o Changes in I § Firms buy new computers, equipment, factories § Expectations, optimism/pessimism § Interest rates, monetary policy § Investment tax credit or tax incentives o Changes in G § Federal spending e.g., defense § State & local spending e.g., roads, schools o Changes in NX § Booms/recessions in countries that buy our exports 3 § Appreciation/depreciation resulting from international speculation in foreign exchange market • The Aggregate-Supply (AS) Curves o The AS curve shows the total quantity of g&s firms produce and sell at any given price level o AS is § Vertical in the long run § Upward sloping in the short run • The Long-Run Aggregate-Supply Curve (LRAS) o The natural rate of output (YN ) is the amount of output the economy produces when unemployment is at its natural rate o (Y N) is also called potential output or full-employment output • Why LRAS is Vertical o (Y N) determined by the economy’s stocks of labor, capital, and natural resources, and on the level of technology o An increase in P does not affect any of these, so it does not affect (N) (classical dichotomy) • Why the LRAS Curve Might Shift o Changes in natural resources § Discovery of new mineral deposits § Reduction in supply of imported oil § Changed in weather patterns that affect agricultural production o Changes in technology § Productivity improvements from technological progress • Using AD & AS to Depict Long-Run Growth and Inflation 4 o Over the long run, technological progress shifts LRAS to the right and growth in the money supply shifts AD to the right à Result: ongoing inflation & growth in output 5
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