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Topic 18 –Aggregate demand and Aggregate Supply.pdf

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James Pesando

Topic 18 – Aggregate demand and Aggregate Supply Feb 9 – 14 th Outline: 1. Aggregate Demand (AD) -- AD and the Price Level -- Movement along the AD curve -- Shifts in AD Curve 2. Aggregate Supply (AS) -- Aggregate Supply -- Potential Output -- Shifts in AS 3. Macroeconomic Equilibrium -- Short-Run -- Long-Run 4. Output Gap -- Self-correction in long-run (AS shifts) -- Policy intervention in short-run (shift AD)  Aggregate Demand Microeconomics – Perfect Competition Price Question: PPrice SS ee 1. How are equilibrium price and quantity determined? 2. What causes DD or SS to shift? 3. If DD or DD shifts, what happens? DD Quantity Macroeconomics Price PPrice SS ee Same Question! DD Quantity AE Schedule: price level is fixed; but in real world, price level does vary Introduce: Aggregate Demand (AD) curve  AD and the Price Level: The AD Curve AD = C + I + G + (X−M) *When we see AD instead of AE, the intuition is that the price level varies;  AD is downward sloping: Price level (P) ↑→ AD↓: The desired spending for domestically produced goods and services decline. Why AD is negatively sloped (motivation)(two channels): 1. P↑ → wealth↓ → C↓ Price level rises, household holdings of money (cash, bank deposits) decline in real terms (buying power), making households less wealthy; 2. P↑ → X↓ M↑ For given exchange rate, X become more expensive to foreign buyers and M become less expensive for domestic buyers. e.g. P 1P 0 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)  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 P : C +I+G+X -M =Y 0 0 0 0 0 P 1P 0 C1+I+G+X 1M =1 1 (C1M )0 Y 1Y0= multiplier * (△C + △X –△M) Thus P 1P 0 Y
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