ECON 001 Lecture Notes - Lecture 24: Price Level, Aggregate Demand, Real Wages
Chapter 33
●AS-AD used to explain short-run economic fluctuations
Short run- period of time which prices are fixed.
Use Model to answer 2 questions
1. What causes economic fluctuations?
2. What policies can be adopted to deal with economic fluctuations?
I. Aggregate Demand Curve (AD Curve) (see binder)
AD curve- show the relationship between price level and level of real GDP (Y). Represents
Q: Why is the AD curve downward sloping?
Three Theories
1. Wealth effect: changes in price level affects household consumption (C) . Price
increase → households feel poorer → consumes less goods and services → Y
decreases
2. Interest Rate Effect: Changes in price level affects Investment (I). Must introduce
money market(see graph in binder). Prices increase → in order to buy same basket,
need more money → Md will increase → Md will shift to right → interest rate rises
→ investment falls.
3. Net Export Effect (Exchange Rate Effect): change in price level affects NX. Theory: 1.
Increase in price → more money to buy the same basket → Md increases → interest
rates go up. Step 2 : high interest rate → domestic and foreign bonds are more
attractive. NCO will fall because not enough foreign assets are being purchased by
domestic investors. NCO decreases → NX decreases → Y decreases.
II. Shifts in AD Curve
Key Point: Change in price level will cause movement along AD curve, but not a shift.
1. If C goes up, if I goes up, if G goes up, if NX goes up, if Ms goes up, or T goes down,
AD curve will shift to the right.
2. If any of them fall or taxes go up, AD curve will shift to the left.
(ex) Government decreases taxes
●Households will have more disposable income. (Y-T)
●C increases → GDP increases (see binder)
Document Summary
As-ad used to explain short-run economic fluctuations. Short run- period of time which prices are fixed. Use model to answer 2 questions: what causes economic fluctuations, what policies can be adopted to deal with economic fluctuations, aggregate demand curve (ad curve) (see binder) Ad curve- show the relationship between price level and level of real gdp (y). 2: wealth effect: changes in price level affects household consumption (c) . Price increase households feel poorer consumes less goods and services y decreases. Interest rate effect: changes in price level affects investment (i). Prices increase in order to buy same basket, need more money md will increase md will shift to right interest rate rises. Investment falls: net export effect (exchange rate effect): change in price level affects nx. Increase in price more money to buy the same basket md increases interest rates go up. Step 2 : high interest rate domestic and foreign bonds are more attractive.
