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Lecture 15

ECON 1000 Lecture 15: Chapter 14 Aggregate Demand and Aggregate Supply - March 8, 13 - Lecture 15, 16, 17

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ECON 1000
Patrick Coe

Chapter 14: Aggregate Demand and Aggregate Supply - March 8, 13 - Lecture 15, 16, 17 Figures are from the 4th March 8, 2017 11:00 AM edition text not the 6th edition Introduction AD: aggregate demand • Economy tends to grow over time due to factor accumulationand technological progress. AS: aggregate supply • But in some years growth is slow or even negative. • These are recessions (mild) or depressions (severe). 1. What causes these events? 2. What, if anything, can public policy do about them? • Use model of AD & AS to answer these questions. Economic Fluctuations are Irregular and Unpredictable • Fluctuations are often referred to as the business cycle. • Misleading as the term “cycle” suggests regular and predictable. • Data shows time between recessions can vary a lot. Figure 14.1a Most MacroeconomicQuantities Move Together • Real GDP is the most commonlyused variable to monitor short-run changes in the economy. • But other variables move with it. • While direction of change is often the same magnitude can differ. ○ E.g. investmentmore volatile. Figure 14.1b As Output Falls, Unemployment Rises • When GDP falls the rate of unemployment rises. • Unemploymentrate rose sharply in three of four recessions.Figure 14.1c • As the economyrecovers unemploymentfalls back towards the natural rate. Assumptions of Classical Economics • Previous chapters dealt with what determines macro variables in the long run. - We care about how much income • All based on the classical dichotomy and monetary neutrality we have per capita - Things are measured in money but • Says money does not matter. • "Money is a veil" it doesn’t really matterin determining the outcome of things. Reality of Short-run Fluctuations • Most economistsbelieve classical theory describes long-run but not the short-run. LR: long run ○ E.g. most believe in the LR increased M raises P but not Y. M: moneysupply • But in SR Real and nominal variables are more intertwined. P: price ○ E.g. increased M can temporarilypush Y from LR trend. Y: output • Therefore,we need a new model for the SR. P Model of AD & AS • Model focuses on two variables. Chapter 14 Page 1 • Therefore,we need a new model for the SR. Model of AD & AS P • Model focuses on two variables. 1. Real GDP measures the economy’soutput. 2. Overall price level (e.g. CPI) • Look at the relationship between the two and therefore depart from classical assumption. • AD: quantity of goods HH demand at each price level. • AS: quantity firms produce and supply at each price level. • Y and P adjust so AS = AD. Figure 14.2 Y Not the Same as Before!!! P Market ice-cream S P • Tempting to think of this as a large version of the model before... ○ ...but it is quite different. AS • In market for ice cream the ability to move resources between markets mattered. • This is microeconomicsubstitution. • Here we are trying to explain the overall quantity produced. • Need a macroeconomic theory. D AD Why the AD Curve Slopes Downwards Q Y • Shows quantity of goods demanded at each price level. Figure 14.3 Looks at how people can move between markets and use substitutes Looks at overall goods - The quantity of all goods going up or down • Recall expenditure Y = C + I + G + NX • Look at how C, I and NX are related to P. • Price level and consumption: wealth effect. - P effects C,I and NX M= 100 , P= 2 ---> you can buy 50 units of consumption (100/2=50) or M= 100 , P=1 ---> you can buy 100 units of consumption - As P falls, people want to hold less demand money People better off --> C a bit ○ Money demand goes down P --> money demand --> try to buy other assets --> P of other assets --> interest rate --> Investment Demand --> Consumption Demand Note: the opposite happens if P goes up Ie: Buy a bond and it pays $1000 in one year from now Buy bond for Pb= 900 today (1000-900)/900=0.1111 Bond Price P to Pb= 950 (1000-950)/900=0.0556 • Price level and investment: interest rate effect • Price level and net exports: real exchange rate effect P --> rer --> CDN goods cheaper --> EX NX --> FGN goods more expensive--> IM • A change in price level is a movementalong AD curve. • AD is drawn all else equal, including money supply. • As we change these other things AD shifts. Why AD Curve Might Shift • Events that might shift the AD curve. • Shifts arising from changes in consumption. H/H: house holds C--> H/H thinking about retirement --> Desire to save --> Consumption demand Chapter 14 Page 2 • Shifts arising from changes in consumption. H/H: house holds C--> H/H thinking about retirement --> Desire to save --> Consumption demand --> AD1to AD2 ALTERNATIVE: Stock market boom causes AD2 to AD1 Or Gov cuts taxes causes AD2 to AD1 AD1 AD2 • Shifts arising from changes in investment. 1. If firms are optimisticabout future 2. They will want more K in future 3. Investment Demand UP 4. AD2 to AD1 • Shifts arising from changes in governmentpurchases. G : AD2 to AD1 G : AD1 to AD2 • Shifts arising from changes in net exports. NX--> US enters recession --> US citizens buy less goods from CND EX --> CND NX … AD1 to AD2 OR e --> --> rer --> NX ……… AD2 to AD1 Lecture Break LRAS: Long run aggregate supply AS Preview SRAS: Short run aggregate supply • Shows to
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