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ECO102H1 (155)

aggregate demand & supply

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University of Toronto St. George
James Pesando

AE Schedule: Price level is fixed Price level does vary Introduce: Aggregate Demand (AD) curve AD = C + I + G + (X-M) Price level (P) increases AD decreases Motivation (introductory) 1. P increases Wealth decreases C decreases Household holdings of Money (cash, bank deposits) decline in real terms as price level rises, making households less wealthy. 2. P increases X decreases M increases For given exchange rate, X become more expensive to foreign buyers and M become less expensive for domestic buyers. Example P1>P0 => P0 P1 C=100 + 0.9YD C=75 + 0.9YD X=20 X=18 M = 25 M= 28 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 1. 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 X1M0 Y1 – Y0 = multiplier *(Δ(decrease) + ΔX(decrease) -ΔM(increase)) Thus P1 > P0 Y1 < Y0 th Diagram #1 feb 14 , 2011 Diagram #2 feb 14 , 2011 Shifts in AD curve Example: ΔI = 10 Multiplier = 2 Y1 – Y0 = shift in AD curve =2 * 10 =20 Aggregate Supply (AS) 1. AS: relation between real GDP (firms’ desired production) and price level when prices of factors of production (including wages) are constant. 2. Price level (P) UP = AS UP Intuition: P increase higher profits(since wages and prices of other facotrs of production do not change) firms’ desired production increases AS: Intuition 1. Firm manufactures shirts 2. Signs contracts which -fix wages for one year - fix price of cloth for one year 3.If price level rises, firm’s profits increase, since -price of shirts increases -price of factors of production unchaged 4.Firm responds by increasing production. AS diagram #5 feb. 14 , 2011. Short-run Macroeconomic equilibrium, AD = AS Refer to diagrm #6 from feb 14 , 2011. At P1 1. firms’ desired output is Y1 2. Total desired spending [AD] exceeds Y1 Economic Adjustment 1.firms’ inventories are being (involuntarily) drawn down 2. Firms respond by increasing output and pric
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