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CA (170,000)
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ECON (300)
Chapter 23

ECON 295 Chapter 23: Chapter 23 notes.docx


Department
Economics
Course Code
ECON 295
Professor
Kenneth Ragan
Chapter
23

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Chapter 23
Output and prices in the short run
I) The Demand Side of the Economy
A) Exogenous Changes in the Price Level
The
AE
curve shifts in response to a change in the price level.
Change in price level  affects desired consumption expenditure and desired net exports
a) Changes in Consumption
A rise in the price level lowers the real value of money held by the private sector.
A fall in the price level raises the real value of money held by the private sector.
This change in wealth leads to changes in the amount of desired consumption
expenditure
Changes in the price level change the wealth of bondholders and bond issuers, but because the
changes offset each other, there is no change in aggregate wealth.
b) Changes in Net Exports
When the domestic price level rises, Canadian goods become more expensive compared to
foreign goods.
Canadian consumers increase their consumption of foreign goods.
Foreign consumers decrease their consumption of Canadian goods.
Thus resulting in a downward shift of the
NX
function.
A rise in the domestic price level (with a constant exchange rate) shifts the net export function
downward, which causes a downward shift in the
AE
curve.
A fall in the domestic price level shifts the net export function upward and hence the
AE
curve upward.
B) Changes in Equilibrium GDP
Rise in the price level  equilibrium level of GDP falls.
Fall in the price level  equilibrium level of GDP rises.

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C)The Aggregate Demand Curve
Aggregate demand (
AD
) curve: A curve showing combinations of real GDP and the price
level that make desired aggregate expenditure equal to actual national income.
For any given price level, the
AD
curve shows the level of real GDP for which desired
aggregate expenditure equals actual GDP.
a) The
AD
curve is not a Micro Demand Curve!
The
AD
curve is negatively sloped for 2 reasons:
1. A fall in the price level leads to a rise in private sector wealth, which increases desired
consumption and thus leads to an increase in equilibrium GDP.
2. A fall in the price level (for a given exchange rate) leads to a rise in net exports and thus
leads to an increase in equilibrium GDP.
b) Shifts in the
AD
curve
For a given price level, any event that leads to a change in equilibrium GDP will cause the
AD
curve to shift.
The event could be a change in government policy, such as the level of government purchases
or taxation.
Any change –other than a change in the price level—that causes the
AE
curve to shift will
also cause the
AD
curve to shift.
Such a shift is called an aggregate demand shock.
For a given price level, an increase in autonomous aggregate expenditure shifts the
AE
curve upward and the
AD
curve to the right. A fall in autonomous aggregate expenditure
shifts the
AE
curve downward and the
AD
curve to the left.
c) The Simple Multiplier and the
AD
curve
The simple multiplier measures the size of the change in equilibrium national income in
response to a change in autonomous expenditure when the price level is held constant.
The simple multiplier measures the horizontal shift in the
AD
curve in response to a change
in autonomous desired expenditure.
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