Ch. 27 Aggregate supply and Aggregate Demand

Aggregate Supply

Model of an imaginary market for the total of all the final goods and servies that make up real GDP

The quantity in this market is real GP and the price is the price level measured by the GDP deflator

Quantity Supplied and Supply

Qty of REAL GDP - Total qty of goods and services valued in constant base-year dollars planned to produce during a given period

Depends on:

Qty of labor employed

Qty of physical and human capital

State of technology

Depends on decision made by households and firms about the supply of and demand of labor

Labor market can be

Full employment

Above full employment

Below Full employment

Qty of real GDP supplied is potential GDP, which depends on the full-employment quantity of labor

Its the relationship between the qty of real GDP supplied and the price level.

Different in two time frames

Long-run aggregate supply

Short-run aggregate supply

relationship between the quantity of real GDP supplied and the price level when the money wage rate changes in step with the price level to maintain full employment.

Along the long-run aggregate supply curve, as the price level changes, the money wage rate also changes so the real wage rate remains at the full-employment equilibrium level and real GDP remains at potential GDP.

Relationship between the quantity of real GDP supplied and the price level when the money wage rate, the prices of other resources, and potential GDP remain constant.

Changes in Aggregate Supply

changes when an influence on production plans other than the price level changes.

Potential GDP

Can increase for:

An increase can change in long-run and short-run aggregates

An increase in the full-employment qty of labor

An increase in the qty of capital

An advance in technology

Changes in the Money Wage Rate

When the money wage rate (or the money price of any other factor of production such as oil) changes, short-run aggregate supply changes but long-run aggregate supply does not change

Can change because:

Departures from full employment

Expectations about inflation

Aggregate Demand

Qty of real GDP demanded

The quantity of real GDP demanded (Y ) is the sum of real consumption expenditure (C), investment (I), government expenditure (G), and exports (X ) minus imports (M ). That is, Y = C + I + G + X - M 

Total amount of final goods/services produced in the US that people/business/governments/foreigners plan to buy.

Buying plans depend on:

The price level

Expectations

Fiscal policy and monetary policy

The world economy

Other things remaining the same, the higher the price level, the smaller is the qty of real GDP demanded

Described as

Aggregate demand schedule

Aggregate demand curve

Curves downward because of:

Wealth effect

Substitution effects

When prices level rises but other remain, REAL wealth decreases

REAL wealth is measured in the amount of money in the bank/bonds/stocks/other assets measured in terms of the goods/services that money/bonds/stocks WILL buy

If REAL wealth decreases people will save more, meaning DECREASING consumption

When price rises and other things remain, INTEREST RATES rise

Involves changing timing of purchases of capital and consumer durable goods INTERTEMPORAL SUBSTITUTION EFFECT

Changes

When the price level rises and other things remain the same, the quantity of real GDP demanded decreases

Changes in AD

Factors that influences buying plans

Expectations

Fiscal policy and monetary policy

The world economy

An increase in expected future income increases the amount of consumption goods that people plan to buy today and increases aggregate demand.

Taxes and transfer payments and purchasing goods/services are fiscal policy

Federal Reserve attempt to influence the economy by changing the interest rates and qty of money monetary policy

Exchange rate

Foreign income

MacroEco Trends and Fluctuations

Two time frames for MACROECONOMIC EQUILIBRIUM

Long-run equilibrium

Short-run equilibrium

Occurs when the qty of real GDP = qty of real GDP demand

Occurs when real GDP = potential GDP

Macroeconomic Schools of Thought

Classical

Keynesian

Monetarist

Believes that the economy is self-regulated and it will normally operate on full-employment, provided that monetary policy is not erratic and money growth is steady

Believes the economy is self-regulated and always at full employment

new classical

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Business cycle fluctuations are the efficient responses of a well-functioning market economy

Aggregate demand Fluctations

Technological advances are the most significant on both AS and AD

The money wage rate lies behind short-run AS curve is instantly and completely flexible

Policy

Emphasizes the potential for taxes to stunt incentives and create inefficiency

By minimizing the disincentive effects of taxes, employment, investment, and technological advance are at their efficient levels and the economy expands at an appropriate and rapid pace.

Believes that left alone, the economy will rarely operate at full employment therefore fiscal and monetary policy is required

AD fluctations

Expectations are more significant on AD, based on herd instincts (way of pessimism about future profit that will lead to recession)

AS Response

Money wage behind short-run AS supply curve is very sticky in a downward fashion

Policy response needed

Calls fiscal and monetary policy to actively offset changes in AD that bring recession, if so full employment can be restored

AD fluctuations

Qty of money is most significant influence

determined by Feds

All recessions result from inappropriate monetary policy

AS Response

Same as Keynesian view

Policy

Taxes should be kept low to avoid disincentive effects, provided that qty of money has steady growth path, no active stabilisation is needed

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