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
Silvia Pons - A01193940