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Lecture 19

ECON 3430 Lecture 19: CH23 book powerpoint notes

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York University
ECON 3430
Brenda Spotton- Visano

Aggregate Demand and Supply Analysis Chapter 23 Aggregate Demand Aggregate demand is made up of four component parts: Consumption expenditure: the total demand for consumer goods and services Planned investment spending: the total planned spending by business firms on new machines, factories, and other capital goods, plus planned spending on new homes Government purchases: spending by all levels of government (federal, state, and local) on goods and services Net exports: the net foreign spending on domestic goods and services Deriving the Aggregate Demand Curve The aggregate demand equation: ad Y = C + I + G +NX When inflation rises, monetary authorities react by raising the real interest rate When the real interest rate is higher, the cost of financing purchases of new physical capital becomes higher, so planned investment spending declines Factors that Shift the Aggregate Demand Curve Seven basic factors (referred to as demand shocks) shift the aggregate demand curve: 1. Autonomous monetary policy 2. Government purchases 3. Taxes 4. Autonomous net exports 5. Autonomous consumption expenditure 6. Autonomous investment 7. Financial frictions Leftward Shift in the Aggregate Demand Curve Rightward Shift in the Aggregate Demand Curve Factors That Shift the Aggregate Demand Curve Aggregate Supply Long-run aggregate supply curve Determined by amount of capital and labor and the available technology Vertical at the natural rate of output generated by the natural rate of unemployment Short-run aggregate supply curve Wages and prices are sticky Generates an upward sloping SRAS as firms attempt to take advantage of short-run profitability when price level rises Long- and Short-Run Aggregate Supply Curves Short-Run Aggregate Supply Curve Based on the idea that three factors drive inflation: 1. Expected Inflation 2. Output Gap 3. Price (Supply) Shocks It is upward sloping When output rises relative to potential output (so the output gap is positive) the labour market is tighter and firms raise their prices at a more rapid rate Thus, the AS curve is upward-sloping Shifts in the Aggregate Supply Curves Shifts in the long run aggregate supply curve The long-run aggregate supply curve shifts to the right from when there is: an increase in the total amount of capital in the economy, an increase in the total amount of labor supplied in the economy, an increase in the available technology, or a decline in the natural rate of unemployment An opposite movement in these variables shifts the LRAS curve to the left Shift in the Long-Run Aggregate Supply Curve Shifts in the Short-Run Aggregate Supply Curve There are three factors that can shift the short-run aggregate supply curve: 1. Expected inflation 2. Inflation shocks 3. A persistent output gap Shift in the Short-Run Aggregate Supply Curve from Changes in Expected Inflation and Inflation Shocks Factors That Shift the Short-Run Aggregate Supply Curve Shift in the Short-Run Aggregate Supply Curve from a Persistent Positive Output Gap Equilibrium in Aggregate Demand and Supply Analysis We can now put the aggregate demand and supply curves together to describe general equilibrium in the economy All markets are simultaneously in equilibrium at the point where
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