29 Aggregate Demand Aggregate Supply Mc Graw-Hill Irwin Copyright

29 Aggregate Demand Aggregate Supply Mc. Graw-Hill/Irwin Copyright © 2012 by The Mc. Graw-Hill Companies, Inc. All rights reserved.

Aggregate Demand • Real GDP desired at each price level • Inverse relationship • Real balances effect • Interest effect • Foreign purchases effect LO 1 29 -2

Price level Aggregate Demand AD 0 LO 1 Real domestic output, GDP 29 -3

Price level Changes in Aggregate Demand AD 2 0 AD 3 AD 1 Real domestic output, GDP LO 1 29 -4

Consumer Spending • Consumer wealth • Household borrowing • Consumer expectations • Personal taxes LO 1 29 -5

Investment Spending • Real interest rates • Expected returns • Expectations about future business conditions • Technology • Degree of excess capacity • Business taxes LO 1 29 -6

Government Spending • Government spending increases • Aggregate demand increases (as • LO 1 long as interest rates and tax rates do not change) • More transportation projects Government spending decreases • Aggregate demand decreases • Less military spending 29 -7

Net Export Spending • National income abroad • Exchange rates • Dollar depreciation • Dollar appreciation LO 1 29 -8

Aggregate Supply • Total real output produced at each • LO 2 price level Relationship depends on time horizon • Immediate short run • Short run • Long run 29 -9

AS: Immediate Short Run Price level Immediate-short-run aggregate supply P 1 0 ASISR Qf Real domestic output, GDP LO 2 29 -10

Aggregate Supply: Short Run AS Price level Aggregate supply (short run) 0 Qf Real domestic output, GDP LO 2 29 -11

Aggregate Supply: Long Run Price level ASLR Long-run aggregate supply 0 Qf Real domestic output, GDP LO 2 29 -12

Changes in Aggregate Supply • Determinants of aggregate supply • Shift factors • Collectively position the AS curve • Changes raise or lower per-unit production costs LO 2 29 -13

Changes in Aggregate Supply AS 3 AS 1 Price level AS 2 0 Real domestic output, GDP LO 2 29 -14

Input Prices • Domestic resource prices • Labor • Capital • Land • Prices of imported resources • Imported oil • Exchange rates LO 2 29 -15

Productivity • Real output per unit of input • Increases in productivity reduce costs • Decreases in productivity increase costs Productivity = Per-unit production cost LO 2 total output total inputs = total input cost total output 29 -16

Legal-Institutional Environment • Legal changes alter per-unit costs of output • Taxes and subsidies • Extent of government regulation LO 2 29 -17

Price level (index numbers) Equilibrium 92 104 512 100 512 96 507 514 b $513 510 a 108 508 100 Price Level (Index Number) Real Output Supplied (Billions) $506 AS Real Output Demanded (Billions) 92 502 AD 0 502 510 514 Real domestic output, GDP (billions of dollars) LO 3 29 -18

Increases in AD: Demand-Pull Inflation Price level AS P 2 P 1 AD 2 AD 1 0 Qf Q 1 Q 2 Real domestic output, GDP LO 4 29 -19

Decreases in AD: Recession Price level AS P 1 P 2 b a c AD 1 AD 2 0 Q 1 Q 2 Qf Real domestic output, GDP LO 4 29 -20

Decreases in AS: Cost-Push Inflation Price level AS 2 P 1 AS 1 b a AD 0 Q 1 Qf Real domestic output, GDP LO 4 29 -21

Increases in AS: Full-Employment Price level AS 1 P 3 P 2 P 1 AS 2 b a c AD 2 AD 1 0 Q 1 Q 2 Q 3 Real domestic output, GDP LO 4 29 -22