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Chapter 23

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ECON 110
Ian James Cromb

Chapter 23: Output and Prices in the Short-Run The Demand Side of the Economy Exogenous Changes in the Price Level  The AE curve shifts in response to a change in the price level o The change affects desired consumption expenditures and desired net exports Changes in Consumption  Relationship between the price level & desired consumption has to do with how changes in the price level lead to changes in household wealth & thus changes to desired spending  Much of total wealth in the private sector is held in the form of assets with a fixed nominal value – the most common being money and gov’t/corporate bonds  What money can buy (its real value) depends on the price level AE curve shifts downward o A rise in the price level lowers the real value of money held by the private sector AE curve shifts upward o A fall in the price level increases the real value of money held by them  Bondholders lend money to the gov’t or firms and are repaid at maturity o Rise in price level: decline in wealth for the bondholder, and an increase in wealth for the issuer of the bond  offset each other  no change in aggregate wealth Changes in Net Exports  When domestic prices levels rise, domestic goods become more expensive relative to foreign goods  Domestic people want less, foreigner countries also want less o This rise in the domestic price level shifts the net export function downward which causes a downward shift in the AE curve o A fall in the domestic price level shifts the NX function up, & so to the AE curve Changes in Equilibrium GDP  An exogenous rise in the price level causes a downward shift in the AE curve o When the AE curve shifts downward, the equilibrium level of real GDP falls  An increase in the price level causes an upward shift in the AE curve o This causes the equilibrium level of real GDP to increase Change of Labels  Before horizontal axis used to be actual national income, now it’s real GDP o Real, meaning that the price level changes  must distinguish changes in nominal GDP from changes in real GDP The Aggregate Demand Curve  For any given price level, the AE curve shows the level of real GDP for which desired aggregate expenditure equals real GDP o Price level on vertical axis and real GDP on the horizontal axis  The AD curve relates equilibrium GDP to the price level o Changes in the price level that cause shifts of the AE curve are simply movements along the AD curve  AD curve traces out equilibrium GDP as price lvl changes The AD Curve is Not a Micro Demand Curve!  Micro demand curve: Price of one commodity changes while everything else is constant o Negatively sloped because: 1) price falls, purchasing power of consumers rise; more purchased, 2) price falls, buy more less expensive & less more expensive  First reason does not apply to AD curve because the dollar value of national income is not being held constant as the price level changes and we move along the AD curve  The second reason only applies in a limited way o A change in the exchange rate does lead to a change in international relative prices which will lead to substitution (foreign and domestic products)  The AD curve is negatively sloped for two reasons o The exchange rate (as explained above) o 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 Shifts in the AD Curve  Any event that leads to a change in equilibrium GDP will cause the AD curve to shift  An Aggregate Demand Shock is any shift in the AD curve  Increase in autonomous expenditure causes AE curve to go up & AD curve to shift right  Decrease in autonomous expenditure causes AE curve to go down & AD curve to go left  In order to shift the AE curve, the change in autonomous expenditure must be caused by something other than a change in the domestic price level The Simple Multiplier and the AD Curve  The simple multiplier measures the horizontal shift in the AD curve in response to a change in autonomous desired expenditure  If the price level remains constant and producers are willing to supply everything that is demanded at that price level, the simple multiplier will also show the change in equilibrium income that will occur in response to a change in autonomous expenditure The Supply Side of the Economy The Aggregate Supply Curve  Aggregate supply refers to the total output of p/s that firms would like to produce  The aggregate supply curve is a curve showing the relation between the price level and the quantity of the aggregate output supplied, for given technology and factor prices The Positive Slope of the AS Curve Costs and Output  The AS curve is drawn on the assumption that tech and factor prices are cons
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