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Chapter 23

Chapter 23.docx

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Department
Economics
Course Code
ECON 102
Professor
Ying Kong

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TEXTBOOK NOTES THE DEMAND SIDE OF THE ECONOMY Exogenous Changes in the Price Level Consumption - changes in price level lead to changes in household wealth and thus changes to desired spending - most of the private sectors total wealth is held in the form of assets with a fixed nominal value  ex. money - the real value of money depends on price level  a rise in the price level lowers the real valu of money held by the private sector  a fall in the price level raises the real value of money held by the private sector - government and corporate bonds are also assets that have fixed nominal value  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 - a higher price level means a decrease in wealth which leads to a decrease in autonomous desired consumption = AE curve shifts down - a lower price level means an increase in wealth which leads to an increase in autonomous desired consumption = AE curve shifts up Net Exports - a rise in the domestic price level (with a constant exchange rate) shifts the net export function down = downward AE curve shift - a fall in the domestic price level (with a constant exchange rate) shifts the net export function up = upward AE curve shift Changes in Equilibrium GDP - an exogenous rise in price level causes both net export and consumption functions to decrease causing a downward shift in the AE curve - fall in price level causes increased net exports and consumption resulting in a upward shift in the AE curve The Aggregate Demand Curve - price level and real EQ GDP are negatively related to each other which can be shown by the aggregate demand curve - AE curve has axis of:  H: real GDP  V: desired aggregate expenditure - AE curve in plotted for a given price level - positively sloped - AD curve has axis of:  H: real GDP  V: price level - price level varies - negatively sloped ** For any given price level, the AD curve shows the level of real GDP for which desired aggregate expenditure equals zero*** - a rise in price level causes the AE to shift downward  leads to upward left movement along AD curve = fall in EQ level of GDP - a fall in price level causes the AE to shift upward  leads to downward right movement along AD curve = rise in EQ level of GDP - the AD curve is downward sloping because:  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  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 Shifts in the AD Curve - for a given price level, anything that causes change to EQ GDP will cause AD to shift  change in government policy (taxation, purchases, i-rate)  household consumption expenditure  firms’ investments  foreign demand - any change (other than price level) that causes AE to shift, will also cause the AD to shift = aggregate demand shock  change in price level causes a movement along the AD curve, not a shift - for a given price level, an increase in autonomous aggregate expenditure shifts the AE curve upward and the AD curve to the right - for a given price level, an fall in autonomous aggregate expenditure shifts the AE curve downward and the AD curve to the left Simple Multiplier and AD Curve - when price level is held constant and the AE curve, the simple multiplier measures the size of change in the equilibrium national income when there is a change in autonomous expenditure - in the AD curve the simple multiplier measures the horizontal shift in the AD curve in response to a change in autonomous desired expenditure THE SUPPLY SIDE OF THE ECONOMY Aggregate Supply Curve - aggregate supply refers to the total output of goods and services that firms would like to produce - the aggregate supply curve relates the price level to quantity of output that firms would like to produce and on the assumption that technology and the prices of all factors of production remain constant Positive Slope - the AS is drawn on the assumption that technology and the factors of production remain a constant price - as output rises, unit cost will rise  less productive workers and capital will have to be used - Price-takers  some industries (producers of raw material) contain many small firms that are too small to change the market price set by demand and supply  must accept the market price - If their unit cost rise with output, price-taking firms will produce more only if price increases  they will produce less if the price falls - Price-setters  some industries that produce manufactured products contain few enough firms that each can influence the market price of its product  firms produce different products that are similar enough to be considered the same (ex. cars)  each firm quotes a price that is prepared to sell each of its products at - price-setting firms will increase their prices when they expand their output into the range where costs are rising  they will eventually decrease their prices if a reduction in their output leads to a reduction in cost - the actions of both price-taking and price-setting firms cause the price level and the supply of output to be positively related – the aggregate supply curve is positively sloped The Increasing Slope of the AS Curve - when output is below potential output, firms will have excess capacity  firms will provide more aggregate output only at a higher price level - once output rises above normal capacity, unit costs begin to rise rapidly exponentially causing a price increase to cover growing costs Shifts in the Aggregate Supply Curve - for a given level of output anything that changes firms’ production cost will change the AS cur ve - two important source of change:  prices of inputs  changes in productivity - shifts in the AS curve caused by exogenous variables are called aggregate supply shocks Changes in Input Price - if factor prices rise, current production’s profitabilit
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