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ECN 204 Study Guide - Final Guide: Fractional-Reserve Banking, Mortgage Loan, Aggregate Supply

by @roj

Course Code
ECN 204
Eric Kam
Study Guide

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ECN – Midterm Notes
12 - Aggregate Demand and Aggregate Supply:
Aggregate demand and aggregate supply are the featured elements of the
aggregate demand-aggregate supply model (AD-AS Model)
The aggregate expenditures model is an immediate-short-run model because
prices are assumed to be fixed
AD-AS model is a variable price-variable output model that allows both the price
level and level of real GDP to change
oIt also puts time elements into the picture, distinguishing between the
immediate short run, the short run, and the long run
Aggregate Demand – a schedule or curve that shows the amounts of a nations output
(Real GDP) that buyers collectively desire to purchase at each possible price level
The relationship between the price level (as measured by the GDP price index)
and the amount of real GDP demanded is inverse or negative:
oWhen the price level rises, the quantity of real GDP demanded decreases
(Vise Versa)
Negative Slope – aggregated demand says that if the price level goes up Real
GDP goes down (1 goes up, 1 goes down)
Aggregated Demand Curve:
Slopes downwards because of the following effects of change in the price level:
oReal-Balances Effect:
Higher price level reduces the purchasing power of the public’s
accumulated saving balances
If price goes up real balance goes down
Y Real GDP goes up, therefore if P goes up Y goes down (Closed
Higher price level means less consumption spending
oInterest-Rate Effect:
Price goes up, interest rate goes up, Investment goes down, Real GDP
goes down (Closed Economy)
Higher price level increases demand for money
Increase in money demand will drive up the price paid for its use
oForeign Trade Effect:
Price goes up, (X) exports go down, Net exports go down, (Y) Real
GDP goes down (Open Economy)
The rise in the price level reduces the quantity of Canadian goods
demanded as net exports
Changes in Aggregate Demand:
Change in the price level will change the amount of aggregate spending and
therefore change the amount of Real GDP demanded by the economy
But if one of those things change, the entire aggregate demand curve will shift =
determinant of aggregate demand
Aggregate demand reflects an inverse relationship between the price level and the
amount of real output demanded
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ECN – Midterm Notes
Determinants of Aggregate Demand: Factors that Shift the Aggregate Demand
Change in Consumer Spending:
oConsumer wealth - total $ value of all assets owned by consumers - $ value
of their liabilities
An unexpected decline in asset values will cause an unanticipated
reduction in consumer wealth at each price
oConsumer expectations
Changes in expectations about the future may change consumer
Shifts AD to the right = Expects real income to rise, causing to spend
Shifts AD to the left = Expects lower future income, causing less current
oHousehold borrowing
Consumers can increase their consumption spending by borrowing
Consumers increase their saving rates in order to pay off their debts
Shifts AD to the left
oPersonal taxes - AD goes to the right
Reduction in personal income tax rates rises take-home income &
increases consumer purchases at each possible price level
Tax cuts shift the AD to the right
Tax increases reduce consumption spending & shifts AD to the left
Changes in Investment Spending (Purchase of capital goods)
oDecline in investment spending = Shift AD to the left
oIncrease in investment spending = Shift AD to the right
oReal Interest rates:
Increase in interest rates will raise borrowing costs, lower investment
spending, and reduce aggregate demand
oExpected Returns:
Higher expected returns, increases demand for capital goods = Shift AD
Declines in expected returns, decrease investment = Shift AD left
Expected future business conditions
Degree of Excess Capacity
Business Taxes
Government Spending:
oGovernment spending increases, aggregate demand increases (as long as
interest rates and tax rates do not change)
Shift AD to the right
Ex. More computers for government agencies
oGovernment spending decreases, aggregate demand decreases
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ECN – Midterm Notes
Ex. Less transportation projects
Net Export Spending:
oRise in Canadian exports means increased foreign demand
oDecrease in Canadian imports implies the Canadian consumers have
decreased their demand for products
oNational Income Abroad
oExchange rates
Dollar Depreciation
Dollar Appreciation
Aggregate Supply:
Is a schedule or curve showing the relationship between the price level of output
and the amount of real domestic output that firms in the economy produce
oThe relationship varies depending on the time horizon and how quickly
output prices and input prices can change
oUpward sloping function = positive slope
Aggregate Supply Depends on 3 Time Horizons:
The immediate short run (both input prices & output prices are fixed)
oThe aggregate supply curve is horizontal at an economy's current price level
oWithout output prices fixed, firms collectively supply the level of output that
is demanded at those prices
oThere is nothing to change
oASisr is a horizontal line
The Short-Run (Input prices are fixed, output prices can vary)
oThe short run begins after the immediate short run ends
oIs a period of time during which output prices are flexible but input prices
are either totally fixed or highly inflexible
oThe upward-sloping aggregate supply curve AS indicates a direct (or
positive) relationship between the price level and the amount of real output
that firms will offer for sale
oThe AS curve is relatively flat below the full-employment output
oIt is relatively steep beyond the full-employment output
oPer-unit production cost = total input cost / units of output
The Long-Run (Input prices & output prices can vary)
oFor the economy as a whole, it is the time horizon over which all output and
input prices are fully flexible
oIt begins after the short run ends
oPrice-level changes do not affect firms' profits and thus they create no
incentive for firms to alter their output
oNo fixed inputs in the economy = outputs & input prices are all flexible
Changes in Aggregate Supply:
Determinants of Short-Run Aggregate Supply:
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