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CHAPTER 23.docx

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Economics (Arts)
ECON 209
Paul Dickinson

CHAPTER 23OUTPUT AND PRICES IN THE SHORT RUN Expand model to make price level endogenous variableLEARNING OBJECTIVESWhy exogenous change in price level shifts AE curve and changes equilibrium level of real GDPHow to derive AD curve and what causes it to shiftAS and why it shiftsHow to define macroeconomic equilibriumHow aggregate demand and aggregate supply shocks affect equilibrium real GDP and the price level231 THE DEMAND SIDE OF THE ECONOMYAE curve shows desired AE for each level of GDP at particular price level Equilibrium GDP occurs where desired aggregate expenditure equals actual GDPwhere it intersects with the 45 degree line Exogenous changes in the Price Level AE curve shifts in response to a change in the price level This occurs because a change in the price level affects desired consumption expenditures and desired net exportsUpward when price level falls downward when price level rises Changes in Consumption Relationship between the price level and desired consumption has to do with how change in the price level lead to changes in household wealth and thus to changes in desired spendingMuch of private sectors total wealth is held in form of assets with fixed nominal value ex money government and corporate bondsThe real value of this money depends on the price levelA rise in the price level lowers the real value of money held by the private sector A fall in the price level raises the real value of money held by the private sector Bondsif there is a rise in the price level the repayment to the bondholder is lower in real value than it otherwise would be decline in wealth for bondholder Issuer of bond makes repayment of lower real value experienced experience in wealth Changes in the price level change the wealth of bondholders and bond issuers but because the changes offset each other there is no change in aggregate wealth Summary Rise in price level leads to reduction in real value of private sectors wealth Reduction in wealth leads to a decrease in autonomous desired consumption and thus a downward shift in the AE function Fall in price level leads to rise in wealth and desired consumption and thus upward shift in the AE curve Changes in Net Exports When domestic price level rises Canadian goods become more expensive relative to foreign godsCauses Canadian consumers to reduce their purchases of Canadianmade goods and increase purchases of foreign goods At same time consumers in other countries reduce purchases of now relatively more expensive Canadianmade goods
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