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Chapter 14

Chapter 14 - Aggregate Demand & Aggregate Supply

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Ryerson University
ECN 204
Eric Kam

stWednesday March 21 2012 Chapter 14 Aggregate Demand and Aggregate Supply Introduction Over the long run real GDP grows about 2 per year on average In the short run GDP fluctuates around its trendRecessionsperiods of falling real incomes and rising unemploymentDepressionssevere recessions very rare Shortrun economic fluctuations are often called business cyclesexplaining these fluctuations is difficult and the theory of economic fluctuations is controversial Most economists use the model of aggregate demand and aggregate supply to study fluctuations this model differs from the classical economic theories economists use to explain the long run The Basic Model of Aggregate Demand and Aggregate Supply Economists use the model of aggregate demand and aggregate supply to explain shortrun fluctuations in economic activity around its longrun trendaggregatedemand curve shows the quantity of goods and services that households firms and the government want to buy at each price levelaggregatesupply curve shows the quantity of goods and services that firms choose to produce and sell at each price levelWhy the AD Curve Slopes Downwards YCIGNX Assume G fixed by government policy to understand the slope of AD must determine how a change in P affects C I and NXThe Wealth Effect P and C Suppose P risesThe dollars people hold buy fewer gs goods and services so real wealth is lowerPeople feel poorer ResultC falls the wealth effect concerns the impact of a change in P on wealth not on income when P falls we are implicitly assuming that peoples real incomes are unchanged and we are only considering the impact of the change in their real wealth on their consumption spendingThe Interest Effect P and I Suppose P risesBuying gs requires more dollarsTo get these dollars people sell bonds or other assetsThis drives up interest rates ResultI fallRecall Idepends negatively on interest ratesThe Exchange Rate Effect P and NX Suppose P risesCanadian interest rates rise the interestrate effect
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