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Chapter 6

Week 6 chapter notes

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Department
Economics for Management Studies
Course Code
MGEA06H3
Professor
Iris Au

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Chapter 23 Output and Prices in the Short Run Notes
23.1 The Demand Size of the Economy
Exogenous Changes in the Price Level
x AE curve shifts in response to a change in price level
x this shift occurs because a change in the price level affects desired consumption expenditures and desired net exports
x a rise in the price level lowers the real value of money held by the private sector; a fall in the price level raises the real value of
money held by the private sector
x 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
x a rise in the domestic price level reduces private-sector wealth, which leads to a fall in desired consumption, and thus a
downward shift in the AE curve; a fall in the domestic price level leads to a rise in wealth and desired consumption and thus to
an upward shift in the AE curve
x a rise in the domestic price level shifts the net export function downward, which causes a downward shift in the AE curve; a fall
in the domestic price level shifts the net export function and hence the AE curve upward
Changes in Equilibrium GDP
x when the AE curve shifts downward, the equilibrium level of real GDP falls
x as the AE curve shifts upward, the equilibrium level of real GDP rises
The Aggregate Demand Curve
x aggregate demand (AD) curve—a curve showing combinations of real GDP and the price level that make desired aggregate
expenditure equal to actual national income
x for any given price level, the AD curve shows the level of real GDP for which desired aggregate expenditure equals actual GDP
x a rise in the price level causes the AE curve to shift downward and hence leads to a movement upward and to the left along the
AD curve, reflecting a fall in the equilibrium level of GDP
x a fall in the price level causes the AE curve to shift upward and hence leads to a movement downward and to the right along the
AD curve, reflecting a rise in the equilibrium level of GDP
x aggregate demand shock—any shift in the aggregate demand curve
x for a given price level, an increase in autonomous aggregate expenditure shifts the AE curve upward and the AD curve to the
right; a fall in autonomous aggregate expenditure shifts the AE curve downward and the AD curve to the left
x the simple multiplier measures the horizontal shift in the AD curve in response to a change in autonomous desired expenditure
23.2 The Supply Side of the Economy
The Aggregate Supply Curve
x aggregate supply (AS) curve—a curve showing the relationship between the price level and the quantity of aggregate output
supplied, on the assumption that technology and all factor prices are held constant
x unit cost—cost per unit of output, equal to total cost divided by total output
x if unit costs rise with output, price-taking firms will produce more only if price increases; they will produce less if price falls
x price-setting firms will increase their prices when they expand their output into the range where unit costs are rising; they will
eventually decrease their prices if a reduction in their output leads to a reduction in unit costs
x 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 A(S) curve is upward sloping
Shifts in the Aggregate Supply Curve
x aggregate supply shock—any shift in the aggregate supply (AS) curve
x a change in either factor prices or productivity will shift the AS curve because any given output will be supplied at a different
price level than previously; an increase in factor prices or a decrease in productivity shifts the AS curve to the left; an increase in
productivity or a decrease in factor prices shifts the AS curve to the right
23.3 Macroeconomic Equilibrium
x only at the combination of real GDP and price level given by the intersection of the AS and AD curves are demand behaviour
and supply behaviour consistent
Changes in the Macroeconomic Equilibrium
x aggregate demand and supply shocks are labelled according to their effect on real GDP; positive shocks increase equilibrium
GDP; negative shocks reduce equilibrium GDP
Aggregate Demand Shocks
x aggregate demand shocks cause the price level and real GDP to change in the same direction; both rise with an increase in
aggregate demand, and both fall with a decrease in aggregate demand
x when the AS curve is upward sloping, an aggregate demand shock leads to a change in the price level; as a result, the multiplier
is smaller than the simple multiplier
x the effect of any given shift in AD will be divided between a change in real output and a change in the price level, depending on
the conditions of AS; the steeper the AS curve, the greater the price effect and the smaller the output effect
Aggregate Supply Shocks
x aggregate supply shocks cause the price level and real GDP to change in opposite directions; with an increase in supply, the price
level falls and GDP rises; with a decrease in supply, the price level rises and GDP falls
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Description
Chapter 23 Output and Prices in the Short Run Notes 23.1 The Demand Size of the Economy Exogenous Changes in the Price Level N AE curve shifts in response to a change in price level N this shift occurs because a change in the price level affects desired consumption expenditures and desired net exports N a rise in the price level lowers the real value of money held by the private sector; a fall in the price level raises the real value of money held by the private sector N 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 N a rise in the domestic price level reduces private-sector wealth, which leads to a fall in desired consumption, and thus a downward shift in the AE curve; a fall in the domestic price level leads to a rise in wealth and desired consumption and thus to an upward shift in the AE curve N a rise in the domestic price level shifts the net export function downward, which causes a downward shift in the AE curve; a fall in the domestic price level shifts the net export function and hence the AE curve upward Changes in Equilibrium GDP N when the AE curve shifts downward, the equilibrium level of real GDP falls N as the AE curve shifts upward, the equilibrium level of real GDP rises The Aggregate Demand Curve N aggregate demand (AD) curve—a curve showing combinations of real GDP and the price level that make desired aggregate expenditure equal to actual national income N for any given price level, the AD curve shows the level of real GDP for which desired aggregate expenditure equals actual GDP N a rise in the price level causes the AE curve to shift downward and hence leads to a movement upward and to the left along the AD curve, reflecting a fall in the equilibrium level of GDP N a fall in the price level causes the AE curve to shift upward and hence leads to a movement downward and to the right along the AD curve, reflecting a rise in the equilibrium level of GDP N aggregate demand shock—any shift in the aggregate demand curve N for a given price level, an increase in autonomous aggregate expenditure shifts the AE curve upward and the AD curve to the right; a fall in autonomous aggregate expenditure shifts the AE curve downward and the AD curve to the left N the simple multiplier measures the horizontal shift in the AD curve in response to a change in autonomous desired expenditure 23.2 The Supply Side of the Economy The Aggregate Supply Curve N aggregate supply (AS) curve—a curve showing the relationship between the price level and the quantity of aggregate output supplied, on the assumption that technology and all factor prices are held constant N unit cost—cost per unit of output, equal to total cost divided by total output N if unit costs rise with output, price-taking firms will produce more only if price increases; they will produce less if price falls N price-setting firms will increase their prices when they expand their output into the range where unit costs are rising; they will eventually decrease their prices if a reduction in their output leads to a reduction in unit costs N 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 A(S) curve is upward sloping Shifts in the Aggregate Supply Curve N aggregate supply shock—any shift in the aggregate supply (AS) curve N a change in either factor prices or productivity will shift the AS curve because any given output will be supplied at a different price level than previously; an increase in factor prices or a decrease in productivity shifts the AS curve to the left; an increase in productivity or a decrease in factor prices shifts the AS curve to the right 23.3 Macroeconomic Equilibrium N only at the combination of real GDP and price level given by the intersection of the AS and AD curves are demand behaviour and supply behaviour consistent Changes in the Macroeconomic Equilibrium N aggregate demand and supply shocks are labelled according to their effect on real GDP; positive shocks increase equilibrium GDP; negative shocks reduce equilibrium GDP Aggregate Demand Shocks N aggregate demand shocks cause the price level and real GDP to change in the same direction; both rise with an increase in aggregate demand, and both fall with a decrease in aggregate demand N when the AS curve is upward sloping, an aggregate demand shock leads to a change in the price level; as a result, the multiplier is smaller than the simple multiplier N the effect of any given shift in AD will be divided between a change in real output and a change in the price level, depending on the conditions of AS; the steeper the AS curve, the greater the price effect and the smaller the output effect Aggregate Supply Shocks N aggregate supply shocks cause the price level and real GDP to change in opposite directions; with an increase in supply, the price level falls and GDP rises; with a decrease in supply, the price level rises and GDP falls www.notesolution.com A Word of Warning N many economic events—especially changes in the world prices of raw materials—cause both aggregate demand and aggregate supply shocks in the same economy; the overall effect on real GDP in that economy depends on the relative importance of the two separate effects Summary 23.1 The Demand Side of the Economy N The AE curve shows desired aggregate expenditure for each level of GDP at a particular price level. Its intersection with the 45° line determines equilibrium GDP for that price level. Equilibrium GDP that occurs where desired aggregate expenditure equals actual GDP. A change in the price level changes private-sector wealth and thus causes a shift in the AE curve: upward when the price level falls and downward when the price level rises. This leads to a new equilibrium level of real GDP. N The AD curve plots the equilibrium level of GDP that corresponds to each possible price level. A change in equilibrium GDP following a change in
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