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ECON 110 (199)
Chapter 23

Chapter 23 Notes

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Department
Economics
Course Code
ECON 110
Professor
Ian James Cromb

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Chapter 23 Notes 23.1 The Demand Side of the Economy  Price changes shift AE curve since changes in price affect desired income  A rise in price level lowers the real value of money in the private sector, while a fall decreases it  Price changes for bonds offset each other between the buyer and seller  Rise in price shifts AE curve down and vice-versa  National Income is the same as “Real GDP” (Y)  Aggregate Demand (AD) Curve shows relationship between price level and the equilibrium level of real GDP o Equilibrium GDP is determined by the AE curve for each given price level; they are then plotted at their respective price levels to yield a point of the AD curve o So shifts in the AE curve cause movements along the AD curve  AD curves are negatively sloped because a fall in price level increases the real value of private sector’s holdings, increasing wealth and, with it, desired expenditure. AE falls with equilibrium point, so AD rises point is higher  Changes in the autonomous component of AE shifts AD curve  Aggregate Demand Shock: any change (excluding price) causing the AE curve to shift will also cause the AD curve to shift. Upward shifts in AE cause shifts to the right in AD 23.2 The Supply Side of the Economy  Aggregate Supply (AS) Curve: shows the relationship between price level and the quantity of aggregate output supplied, on the assumption that tech and all factor prices are held constant  Unit Cost: cost per unit of output. This rises as output increases (more capital investment)  The higher the level of output, the faster costs rise (called final symmetry)  Aggregate Supply Shocks: a shift in the AS curve (normally change in input price or change in productivity)  Reduction in AE (rise in input price + reduction in productivity results in upwards and to the left shift of AS 23.3 Macroeconomic Equilibrium  Equilibrium of price and real GDP occurs at intersection between AD and AS curves, called macroeconomic equilibrium o Desired expenditure must equal actual GDP (true anywhere along the AD curve) o At a prevailing price level, firms must be willing to produce the prevailing level of GDP (true everywhere along the AS curve)  AD shifts right (positive shock) real GDP increases, AD shifts left (negative shock) real GDP decreases  AS shifts right (positive shock) real GDP increases, AS shifts left (negative shock) real GDP decreases  Positive AD shocks (increase in government investment/purchases, increase in foreigner’s demand, or increase in household consumption fro reduced personal taxes) cause raises in price  With an upward sloping AS curve, the horizontal shift in equilibrium is smaller than the simple multiplier because it raises price  Multiplier adjusted for effect of price increase is the ration change in income over change in autonomous expenditure Shape of the AS Curve  Flat Range: change in AD leads to no change in price, predicted by simple multiplier  Intermediate Range: AD curve causes appreciable changes in price, positive multiplier but smaller than simple multiplier  Steep Range: Economy is near capacity and change in AD leads to sharp change in price, multiplier is nearly zero  Keynesian AS curve; where AS is horizontal, and the best quantity for a certain price (intersection of the AD curve) is set (demand determined) o Occurs when GDP is below potential, so they decide to produce under normal capacity  A vertical AS curve means output cannot be expanded to satisfy increased demand, so AE and equilibrium are unchanged Aggregate Supply Shocks  Cause price and real GDP levels to move in opposite directions  Increased supply lowers prices and raises GDP, and vice-versa  Many economic events cause both AD and AS shocks; the overall effect depends on the relative importance of each
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