Chapter 14.docx

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26 Mar 2012
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Chapter 14: Aggregate Demand and Aggregate Supply
- Real GDP grows 2% per year on average
Recessions: periods of falling real incomes and rising unemployment
Depressions: sever recessions
Facts About Economic Fluctuations
1. Economic fluctuations are irregular and unpredictable
2. Most macroeconomic quantities fluctuate together
3. As output falls, unemployment rises
Model of aggregate demand and aggregate supply: used to study fluctuations, differs from classical
economic theories economists use to explain the long run
Aggregate demand curve: shows the quantity of g&s that households, firms and gov’t want to buy at
each price level.
Aggregate supply curve: shows the quantity of g&s that firms choose to produce and sell at each price
level
- AD curve shows the quantity of all g&s demanded in the economy at any given price level
Y = C + I + G + NX
- Assume G is fixed
- We must determine how a change in P affects C, I and NX
The Wealth Effect (P and C, negative relationship)
Suppose P rises
- Dollars people hold buy fewer g&s. so real wealth is, lower, people feel poorer
Result: C falls
The Interest Rate Effect (P and I, negative relationship)
Suppose P rises
- Buying g&s requires more dollars
- To get these dollars, people sell bond or other assets
- This drives up interest rates
Result: I falls
The Exchange-Rate Effect (P and NX)
Suppose P rises
- Canadian interest rates rise
- Foreign investors desire more Canadian bonds
- Higher demand for $ in foreign exchange market
- Canadian money worth more
- Exports more expensive to people abroad, imports cheaper to Canadian residents
Results: NX falls
P rises -> R rises -> D for C$ rises -> X falls, imports rise
Any event that changes C I G or NX, except change in P, will shift AD curve.
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