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Chapter ch 9

EDRD 1400 Chapter Notes - Chapter ch 9: Nominal Rigidity, Aggregate Supply, Aggregate Demand


Department
Environmental Design and Rural Development
Course Code
EDRD 1400
Professor
Maurice
Chapter
ch 9

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ECON 1100 Chapter 9 Notes Tyler Zedic
Chapter 9 Aggregate Demand and Aggregate Supply Analysis
Key Terms
Aggregate Demand and Aggregate Supply Model: A model that explains short-run fluctuations in
real GDP and in the price level.
Price Level: A measure of the average prices of goods and services in the economy.
Aggregate Demand (AD) Curve: A curve that shows the relationship between the price level and
the quantity of real GDP demanded by households, firms, and the government.
Short-Run Aggregate Supply Curve ((ASSR): A Curve that shows the relationship in the short run
between the price level and the quantity of real GDP supplied by firms.
Monetary Policy: The actions the Bank of Canada takes to manage the money supply and
interest rates to pursue macroeconomic policy goals.
Fiscal Policy: Changes in federal taxes and purchases that are intended to achieve
macroeconomic policy objectives.
Potential GDP: The Level of real GDP attained when all firms are producing at capacity.
Long-Run Aggregate Supply Curve (ASLR): A curve that shows the relationship in the long run
between the price level and the quantity of real GDP supplied.
Menu Costs: The costs to firms of changing prices.
Supply Shock: AN unexpected event that causes the short-run aggregate supply curve to shift.
Stagflation: A combination of inflation and recession, usually resulting from a supply shock.
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ECON 1100 Chapter 9 Notes Tyler Zedic
Key Information
9.1 Aggregate Demand
- To understand what happens during the business cycle, we need an explanation of why real
GDP, the unemployment rate, and the inflation rate fluctuate
Unemployment rate fluctuations mostly caused by fluctuations in real GDP
- The aggregate demand and aggregate supply model can be used to explain fluctuations in real
GDP and the price level
In this model, real GDP and the price level are determined in the short run by the
intersection of the aggregate demand curve and aggregate supply curve
- Fluctuations in real GDP and the price level are caused by shifts in the aggregate demand curve,
the aggregate supply curve, or both
- AD curve shows the relationship between the price level and the quantity of real GDP
demanded by households, firms, and the government
- The Short-Run Aggregate Supply Curve (ASSR) shows the relationship between the price
level and the quantity of real GDP supplied by firms in the short run
- Aggregate supply and aggregate demand curves are similar to individual market demand
and supply curves
However, because these curves apply to a whole economy and not a singular
market, the aggregate demand and aggregate supply model is quite different
from the demand and supply model for the individual market
- We need macroeconomic explanations for why the aggregate demand curve is
downward sloping, why the short-run aggregate supply curve is upward sloping, and
why the curves shift
Why Is the Aggregate Demand Curve Downward Sloping?
- GDP (Y) has four components: Consumption (C), Investment (I), Government Purchases (G), and
Net Exports (NX)
We derive the equation: Y = C + I + G + NX
- The aggregate demand curve is downward sloping because a fall in the price level increases the
quantity of real GDP demanded
- We can consider the effect of changes in the price level on each of the three remaining
components of real GDP after ruling out price level changes do not influence Government
purchases consumption, investment, and net exports
The Wealth Effect: How a Change in the Price Level Affects Consumption
- A household’s ealth deteries the leel of osuptio  that household
Household Wealth = Value of Assets Value of Debts
- As household wealth rises, consumption rises; vice versa as household wealth falls,
consumption falls
- Some household wealth is held in cash or other nominal assets assets whose value falls as the
price level rises or gains value as the price level falls
- As the price level in an economy increases, the lower consumption spending will occur
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ECON 1100 Chapter 9 Notes Tyler Zedic
- When the price level in an economy decreases, the more consumption spending will occur
- Wealth Effect is the impact of the price level on consumption; one reason for the downward
sloping aggregate demand curve
The Interest-Rate Effect: How a Change in the Price Level Affects Investment
- as prices rise, households and firms will need more money to finance buying and selling
- when prices rise, households will try to increase the amount of money they hold by withdrawing
funds from banks, borrowing from banks, or selling financial assets
actions drive up the interest rate charged on bank loans and the interest rate on bonds
higher interest rate will make the cost of borrowing for firms and households
even greater
as a result, firms borrow less to build new factories or install new machinery and
equipment; households borrow less to purchases new houses
- higher price level increases the interest rate, reduces investment spending, and reduces the
quantity of goods and services demanded
- lower price level will decrease the interest rate, increase investment spending, thereby
increasing the quantity of goods and services demanded
- Interest-Rate Effect is the impact of the price level on interest rates and investment spending;
another reason for downward sloping demand curve
The International-Trade Effect: How a Change in the Price Level Affects Net Exports
- net exports is the difference between the goods produced in Canada, but purchased by foreign
firms and households and the goods produced in other countries, but purchased by Canadian
households and firms
- when the price level in Canada rises relative to price level in other countries, Canadian exports
will become more expensive, foreign made products will become less expensive
exports fall; imports rise; net exports fall => reduces the quantity of goods and services
demanded
- when the price level in Canada falls relative to the price level in other countries, Canadian
exports will become less expensive, foreign made products will become more expensive
exports rise; imports fall; net exports rises => increases the quantity of goods and
services demanded
- International-Trade Effect is the impact of the price level on net exports; the final reason the
aggregate demand curve is downward sloping
Shifts in the Aggregate Demand Curve vs. Movements Along It
- If the price level changes but other variables that affect the willingness of households, firms, and
the government to spend are unchanged, the economy will move along a stationary aggregate
demand curve
- If any variable other than the price level changes, the aggregate demand curve will shift
- Simple way to know whether a movement along, or shift of the curve will occur is to check the
variable causing a change and the axis
If the variable that changes is on either the x or y axis, there is a movement along the
curve
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