Chapter 12 - Summary Macroeconomics PDF

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Chapter 12 - Aggregate Demand and Aggregate Supply Aggregate Demand ● Aggregate demand ○ Schedule or curve that shows the amount of a nation’s output (real GDP) that buyers collectively desire to purchase at each possible price level ○ inverse/negative curve ○ When price level rises, the quantity of real GDP demanded decreases ○ When the price level falls, the quantity of real GDP demanded increase ● Aggregate Demand Curve ○ The inverse relationship between the price level and real GDP ○ AD curve slopes downwards, as does the demand curve for an individual product ○ When the economy moves down its aggregate demand curve - it moves to a lower general price level ● 3 effects of a price-level change ○ Real-balances effect ■ Change in the price level ■ Higher price level reduces the real value or purchasing power of the public’s accumulated savings balances ○ Interest-rate effect ■ Aggregate demand curve also slopes downwards ■ When price level rises, consumers need more money for purchases and businesses need more money to meet their payrolls and to buy other resources ■ Higher interest rates curtail investment spending and interest-sensitive consumption spending ○ Foreign purchase effect ■ When the US price level rises relative to foreign price level, foreigners buy fewer US goods and Americans buy more foreign goods Changes in Aggregate Demand ● Determinants of aggregate demand ○ Aggregate demand shifters ○ 2 components ■ A change in one of the determinants of aggregate demand that directly changes the amount of real GDP demanded ■ A multiplier effect that produces a greater ultimate change in aggregate demand than the initial change in spending ● Determinants of aggregate demand - factors that shift the aggregate demand curve ○ Change in consumer spending ■ Consumer wealth ■ Consumer expectations ■ Household borrowing ■ Taxes

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Change in investment spending ■ Interest rates ■ Expected returns ● Expected future business conditions ● Technology ● Degree of excess capacity ● Business taxes Change in government spending Change in net exports ■ National income abroad ■ Exchange rates

Aggregate Supply ● Aggregate supply ○ Schedule or curve showing the relationship between a nation’s price level and the amount of real domestic output that firms in the economy produce ○ 3 time horizons ■ Immediate short run - both input prices and output prices are fixed ■ Short run - input prices are fixed, but output prices can vary ■ Long run - input prices as well as output prices can vary ● Immediate-short-run aggregate supply curve (ASISR) ○ Horizontal line at the overall price level PI, which is calculated from all of the individual prices set by the various firms in the economy ○ Horizontal shapes implies that the total amount of output supplied in the economy depends directly on the volume of spending that results at price level PI ● Short-run aggregate supply curve (AS) ○ Slopes upward - with input prices fixed, changes in the price level will raise or lower real firm profits ○

Per-unit production cost =

total input cost units of output

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As the economy expands in the short run, per-unit production costs generally rise because of reduced efficiency Long-run aggregate supply curve (ASLR) ○ Veral line at the economy’s full-employment output Qf ○ Long run the economy will produce the full-employment output level no matter what the price level is ○ Outcome - totally dependent on the fact that input prices are fixed in the short run

Changes in Aggregate Supply ● Determinants of aggregate supply ○ Aggregate supply shifters - collectively position the aggregate supply curve and shift the curve when they change ● Determinants of aggregate supply - factors that shift the aggregate supply curve ○ Change in input

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Domestic resource prices ● Labor supply increases because of substantial immigration ● Wages and per-unit production costs fall, shifting the AS curve to the right ● Labor supply decreases because a rapid increase in pensions ● Wage rates and per-unit production costs rise, shifting the AS curve to the left ■ Prices of imported resources Change in productivity ■ Measure of the relationship between a nation’s level of real output and the amount of resources used to produce that output ■

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Productivity =

Total output Total inputs

Change in legal-institutional environment ■ Business taxes and subsidies ● Higher business taxes increase per-unit costs and reduce shortrun aggregate supply ■ Government regulation

Equilibrium in the AD-AS Model ● The intersection of the aggregate demand curve AD and the aggregate supply curve AS establishes the economy’s equilibrium price level and equilibrium real output ● Jointly establish the price level and level of real GDP Changes in Equilibrium ● Increases in AD: demand-pull inflation ○ Actions that shift the aggregate demand curve to the right ○ The price level is being pulled up by the increase in aggregate demand ● Decreases in AD: recession and cyclical unemployment ○ Decreases in aggregate demand describe the opposite end of the business cycle ○ Reasons for downward price stickiness ■ Fear of price wars ● Successively deeper and deeper rounds of price cuts ■ Menu costs ● Firms that think a recession will be relatively short-lived may be reluctant to cut their prices ● Other costs from trying to lower costs ○ Estimating the magnitude and duration of the shift in demand to determine whether prices should be lowered ○ Repricing items held in inventory ○ Printing and mailing new catalogs ○ Communicating new prices to customers ■ Wage contracts ● Wages usually inflexible downwards

● Firms rarely profit from cutting product prices Morale, effort, and productivity ● Efficiency wages - wages that elicit maximum work effort and thus minimize labor costs per unit of output ■ Minimum wage Decreases in AS: cost-push inflation ○ Aggregate supply curve would shift to the left Increases in AS: Full Employment with Price-level stability ○ AD and AS both shift to the right ■

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