ECN 204 Study Guide - Final Guide: Phillips Curve, Aggregate Demand, Fiscal Policy

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26 Feb 2015
Macroeconomics (AFTER MIDTERM)
Aggregate Expenditure Model
x-axis = AE (plant total spending) y-axis = Y (GDP)
ðñ[o]vÁZAz (short-term) (]vµ]o]]µuÁZðñ[o]vu
AE = C + I + G + NX
Aggregate Supply & Demand Model
- Shows how economic factors & policies can simultaneously affect overall price level along with
real output; price does not chance
- Deals with changes in overall price level of economy
o Consumer Price Index, not inflation
o General level of prices directly determines purchasing power of money
o Stagflation was difficult to explain with Keynesian cross model;
Stagflation = economy experience high inflation & high employment
Aggregate Demand (AD)
- Amounts of real output that buyers collectively desire to purchase at each possible price level
- Planned AE & AD:
- Price level falls WEW[
- Output level increase z[Ez
- Downward slope to AD
(Aggregate Demand)
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Aggregate Demand (AD)
- Slopes downward because of following effects of change in price level:
1. Real-balances effect t directly related to price & how much money to hold
price X= purchasing power Y; demand Y
2. Interest-rate effect t money demand, ability to hold cash in pockets; money supply
normally fixed, but money demand not fixed
money demand XUv}ZvP]vµAhigh interest rate
Change in investment
3. Foreign trade effect t export t imports = net exports
exports falling, importsX; domestic products price X, demand Y
- AD shifts = demand shock (negative left/right positive); due to other factors other than price
changing our behavior
Determinants of Aggregate Demand
- Consumer spending
x Consumer wealth, consumer expectations, taxes, household indebtedness
- Investment Spending
x Real interest rates
x Expected returns
Expectations about future business conditions
Degree of excess capacity
Business taxes
- Government Spending
- Net Export Spending
x National income abroad, exchange rates
Aggregate Supply
- Level of real domestic output that will be produced at each price level; input & output prices
- Production responses to price level changes differ in long run & short run
long run t economy can only produce up to potential GDP
short run t produce more?
- Input prices t contracts, prices cannot change for long period of change
- Output prices t surplus/shortage influence price
Aggregate Supply Long Run
- s]o}v}uÇ[(µoo employment output (potential GDP)
- Wages & other input prices rise/fall to match changes in price level
- ZvP]v]oÀo}v[ZvPo}(]Z[v}ZvP]vooutput
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Aggregate Supply Short Run SLIDE 16
- In reality, nominal wages adjust only slowly to changes in price level
- Curve is upward-sloping
- As economy expands, per-unit production costs generally rise
- Extent of rise depends on where economy is operating, relative to its capacity
x Economy operating below full-employment output has idle capital & labour W little
upward pressure on production costs
x When operating beyond its full-employment output, most available resources are
already employed W per-unit production costs increase as economy expands
Determinants of Aggregate Supply
1. Change in input prices
x Domestic resource price
x Price of imported resources
x Market power
2. Change in productivity
3. Change in legal-institutional environment
x Business taxes & subsidies
Supply shock t shift due to cost of production; increase cost of production = left, decrease in cost of
production = right
Increases in AD (positive shock)
- For any initial increase in AD, resulting increase in real output will be smaller the greater is the
increase in price level
Decrease in AD (negative shock)
- Deflation is rare; prices not easily adjusted downwards
- Zo}µµl(µooµv}(o]v]vµ}µ]^]lÇ_]vZ}µv
x Wage contracts
x Morale, effort, & productivity
x Minimum wage
x Menu costs
x Fear of price wars
- Sticky prices t inflexible prices
Decrease in AS: Cost-Push Inflation
- Effects of leftward shift in AS are doubly bad (negative shock)
x Output decreases, price level increases
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