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Chatper 15 Aggregate demand and supply notes

by: Henry Notetaker

Chatper 15 Aggregate demand and supply notes ECON 2133

Marketplace > East Carolina University > Economcs > ECON 2133 > Chatper 15 Aggregate demand and supply notes
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Covers Aggregate Demand and Supply while also going over the correlation between the two.
Nehad Elsawaf
Class Notes
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This 5 page Class Notes was uploaded by Henry Notetaker on Tuesday April 26, 2016. The Class Notes belongs to ECON 2133 at East Carolina University taught by Nehad Elsawaf in Spring 2016. Since its upload, it has received 26 views. For similar materials see Macroeconomics in Economcs at East Carolina University.


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Date Created: 04/26/16
Chapter 15 Aggregate Demand and Supply In this chapter we go over John Maynard Keynes’ view on economic demand and supply I) Introduction a) Over the long run, real GDP grows about 3% per year on average. b) In the short run, GDP fluctuates around its trend. i) Recessions: Periods of falling real incomes and rising unemployment. ii) Depressions: Severe recessions (very rare) c) Short-run economic fluctuations are often called business cycles. II) 3 Facts about Economic Fluctuations a) Fact 1: Economic fluctuations are irregular and unpredictable. b) Fact 2: Most macroeconomic quantities fluctuate together. c) Fact 3: As output falls, unemployment rises. III) Introduction, cont. a) Explaining these fluctuations is difficult, and the theory of economic fluctuations is controversial. b) Most economists use the model of aggregate demand and supply to study fluctuations. c) This model differs from the classical economic theories economists use to explain the long run. IV)Classical Economists – a recap a) The previous chapters are based on the ideas of classical economics, especially: i) The Classical Dichotomy: The separation of variables into two groups: (1)Real- quantities, relative prices (2)Nominal- measured in terms of money ii) The Neutrality of Money: Changes in the money supply affect nominal but not real variables. iii) Most economists believed classical theory describes the world in the long run, but not in the short-run. iv) In the short-run, changes in the nominal variables (like the money supply or P) can affect real variables (like Y or the U-rate) b) The Model of Aggregate Demand & Supply i) The model determines the equilibrium price level. (1)And equilibrium output (real GDP) SRAS- Short-Run P Aggregate Supply P AD- Aggregate Demand V) The Aggregate- Demand (AD) Curve a) The AD Curve shows the quantity of all G&S demanded in the economy at any given price level. b) AD = C + I + G (constant) + NX i) Change in P = C goes down (wealth effect) ii) Change in P = I goes down (Interest Rate effect) iii) Change in P = NX goes down (exchange rate effect) P P1 AD Y Y1 VI)Why the AD Curve Slopes Downward a) Y=C+I+G+NX b) Assume G is fixed by gov’t policy c) TO understand the slope of AD, we must determine how a change in P effects C, I, and NX VII) The Wealth Effect (Change of P on C) a) Suppose P rises. i) The dollars people hold buy fewer G&S, so real wealth is lower. ii) People feel poorer. b) Result: C falls VIII) The Interest-Rate Effect (Change of P on I) a) Suppose P rises. i) Buying G&S requires more dollars ii) To get these dollars, people sell bonds or other assets iii)This drives up interest rates b) Result: I falls i) Recall, I depend negatively on interest rates. IX) The Exchange-Rate Effect a) Suppose P rises. i) U.S. interest rate rise (the interest-rate effect) ii) Foreign investors desire more U.S. bonds iii)Higher demand for $ in foreign exchange market. iv)U.S. exchange rate appreciates (1) Our $ gets stronger v) U.S. exports more expensive to people abroad, imports cheaper to U.S. residents vi)Result: NX falls X) The Slope of the AD Curve: Summary a) An increase in P reduces the quantity of G&S demanded because: i) The wealth effect (c falls) ii) The interest rate effect (I falls) iii)The exchange rate effect (NX falls) XI) Why the AD Curve Might Shift a) Any event that changes C,I,G, or NX-except a change in P- will shift the AD curve Example: A stock market boom makes households feel wealthier, C rises, the AD shifts right. a) Changes in C i) Stock market boom/crash ii) Preferences, re: consumption, saving, trade-offs iii) Tax hikes/cuts b) Changes in I i) Firms buy new computers, equipment, factories ii) Expectations, optimism/ pessimism iii) Interest rates, monetary policy iv) Investment Tax Credit or other tax incentives c) Changes in G i) Federal spending, e.g., defense ii) State and local spending, e.g., roads, schools d) Changes in NX i) Booms/recessions in countries that buy our exports ii) Appreciation/depression resulting from international speculation in foreign exchange market. Aggregate Supply The AS-Curve shows the total quantity of G&S firms produce and sell at any given price level. AS is: Upward sloping in short run LRAS SRA Vertical in long run I) The Long-run Aggregate-Supply Curve (LRAS) a) Why the AS is vertical in the L.R.: i) Natural Rate of Output (Yn): The amount of output the economy produces when unemployment is at its natural rate. ii) Yn is also called potential output or full-employment output. iii) Yn is NOT determined by price but other variables. iv) An increase in P does not affect Yn (classical dichotomy) II) Why the LRAS Curve Might Shift a) Changes in L or natural rate of unemployment i) Immigration ii) Baby-boomers retire iii) Gov’t policies reduce natural u-rate b) Changes in K or H i) Investments in factories, equipment ii) More people get college degrees iii) Factories destroyed by a hurricane c) Changes in Natural resources i) Discovery of new mineral deposits ii) Reduction in supply of imported oil iii) Changing weather patterns that affect agricultural production d) Changes in Technology i) Productivity improvements from technological progress. III) Short-Run Aggregate Supply Curve (SRAS) a) The SRAS is slopped upward: over the period of 1-2 years. i) An increase in price causes an increase in the quantity of G&S supplied. IV)Why the Slope of SRAS Matters a) If AS is vertical, fluctuations in AD do not cause fluctuations in output or employment. b) If AS slopes up, then shifts in AD do effect output and employment. V) Why the SRAS Curve Might Shift a) Everything that shifts LRAS shifts SRAS, too. b) Pe shifts SRAS: i) If Pe rises, workers and firms set higher wages. ii) At each P, production is less profitable, Y falls, SRAS shifts left. (1)Pe is Price equilibrium VI)Economic Fluctuations a) Caused by events that shift the AD and/or AS curves. b) 4 Steps to analyze economic fluctuations: (1)Determine whether the event shifts the AD or AS. (2)Determine whether the curve shifts left or right. (3)Use AD-AS diagram to see how the shift changes Y and P in the short-run (4)Use AD-AS diagram to see how economy moves from new SR equilibrium to new LR equilibrium. VII) John Maynard Keynes, 1883-1946 a) Father of the Keynesian theory of economics b) The General Theory of Employment, Interest, and Money, 1936 (Book) c) Argued recessions and depressions can result from inadequate demand; policymakers should shift AD.


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