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Lecture

ECO102H1 Lecture Notes - Perfect Competition, Economic Equilibrium, Shortage


Department
Economics
Course Code
ECO102H1
Professor
James Pesando

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AE Schedule: price level is fixed;
but in real world, price level does vary
Introduce: Aggregate Demand (AD) curve
z AD and the Price Level: The AD Curve
๎€„๎€˜๎€ƒA๎€ƒ๎€’๎€ƒ=๎€ƒ/๎€ƒ=๎€ƒ'๎€ƒ=๎€ƒ~y>D๎ฟ๎€ƒ
*When we see AD instead of AE, the intuition is that the price level varies;
z AD is downward sloping:
Price level (P) ๎€–๎€— AD๎€˜: The desired spending for domestically produced goods and services decline.
Why AD is negatively sloped (motivation)(two channels):
1. P๎€– ๎€— wealth๎€˜ ๎€— C๎€˜
Price level rises, household holdings of money (cash, bank deposits) decline in real terms (buying power),
making households less wealthy;
2. P๎€– ๎€— X๎€˜ M๎€–
For given exchange rate, X become more expensive to foreign buyers and M become less expensive for
domestic buyers.
e.g. P1>P0
P0 P1
C=100+0.9YD C=75+0.9YD
X=20 X=18
M=25 M=28
Example:
Household Wealth and Consumption
1. Wealth (as well as disposable income) influences consumption
2. Household has $10,000 in cash
3. Price level increases by 10%
4. Purchasing power of $10,000 cash declines to $9,000
5. Household reduces consumption (change in autonomous consumption)
z Deriving the AD Curve (from AE schedule)
1. Recall: AE schedule (drawn for a fixed price level!!!)
2. AE Schedule shifts down as price level increases
P0: C0+I+G+X0-M0=Y0
P1>P0: C1+I+G+X1-M1=Y1 (C1<C0; X1<X0; M1>M0)
Y1-Y0 = multiplier * (ยธC + ยธX tยธM)
Thus P1>P0 รŽ Y1<Y0
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