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Chapter 33

Ch. 33 Aggregate Demand & Aggregate Supply.docx

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Mu- Chun Chen

Ch. 33 Aggregate Demand & Aggregate Supply I. 3 key facts about economic fluctuations - Recession: period of declining real incomes and rising unemployment - Depression: severe recession A. Fact 1: economic fluctuations are irregular and unpredictable - Business cycle: fluctuations in econ, not regular impossible to predict B. Fact 2: most macroeconomic quantities fluctuate together - real gdp measure all goods and supply within period of time (short run) changes - when econ. Conditions deteriorate, much is cause of reductions in spending on new capital C. Fact 3: As output falls, unemployment rises - Unemployment rate never approaches zero - Recession causes rise in unemployment when real gdp declines II. Explaining short run Econ fluctuations A. Assumptions of classical economics - classical dichotomy: separation of variables into real variables - classical macroeconomic theory: changes in money supply affect nominal variables but not real variables - monetary neutrality - money doesn’t matter in classical world, real variable more important than nominal because it’s the forces of econ B. Reality of short run fluctuations - most economics believe that classical theory describes the world in the long run but not short run - must abandon classical dich. Instead see interaction where change in money supply push real gdp away from long run trend C. Model of Aggregate Demand and Aggregate Supply - explaining short run fluctuations in econ activity around its long run trend - econ’s output good & supply (real var) - ave. lvl. Prices ( nominal var) -aggregate demand curve: shows Q of g & s that households, firms, gov, and customers abroad want to buy at each price level - aggregate supply curve: Q of g & S firms choose to produce and sell at each price level - Price level and Q of output bring demand and supply into balance III. Aggregate demand curve - econ gdp = y = C+I+G+NX 1. Price level & Consumption: Wealth Effect - nom value: is fixed - real value changes by price level - price level decreases as prie level increases - price level decreases and real value increases of money and makes consumers wealthier and spend more - spending more means more goods and services demanded and vice versa 2. Price level and investment: interest rate effect - lower rice level decreases interest rate so more spending on investment and increase Q of g&s demanded 3. price level and net exports: exchange rate effect - fall in US price level cause interest rate to fall real value of price declines in foreign market so stimulates net exports and increase Q g&S demanded and vice versa A. Why aggregate Demand curve might shift? 1. shift arising from changes in consumption - event makes consumer spend more (tax cut, stock boom) shift to right, if spend less (tax stock decrease) then shift left 2. shift from changes in investment - event make firm invest more shifting R, and vice versa 3. shifts from changes in government purchase - government purchases increase shifts right and vice versa 4. shift changes in net exports - event increases spending on net exports shifts right, vice versa IV. Aggregate supply curve A. Why aggregate supply curve vertical in long run - long run
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