Chapter 23 Real GDP and the Price Level in the Short Run PDF

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SUmmary of chapter 23 in the text!...

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Chapter 23: Real GDP and the Price Level in the Short Run 23.1: The Demand Side of the Economy ❏ The AE Curve shifts in response to a change in the price level, a change in the average price of all the goods and services in the economy ❏ The shift occurs because a change in the price level affects desired consumption expenditures and desired net exports Change in Consumption ❏ The relationship between price level and desired consumption has to do with how changes in price level leads in changes in household wealth and thus to desired spending ❏ A rise in the domestic price level lowers the real value of money holdings, and vice versa ❏ Govt bonds: a rise in the price level means that the repayment to the bondholder is lower in real value then it would have been if it didn’t change ❏ A rise in the domestic price level (with a constant exchange rate) reduces net exports and causes a downward shift in the AE curve. A fall in domestic price level increases net exports and causes an upward shift in the AE curve Changes in Equilibrium GDP ❏ Since it reduces both desired consumption and desired net exports, an exogenous rise in the price level causes a downward shift in the AE curve. ❏ When the AE curve shifts downward, the equilibrium level of real GDP falls. ❏ With a fall in prices, Cdn goods become cheaper internationally so net exports rise. Purchasing power of nominal goods increases so households spend more. THis causes AE curve is shift upward, and equilibrium level of GDP rises The Aggregate Demand Curve ❏ Since price level and real equilibrium GDP are negatively related, they are shown with the aggregate demand curve ❏ AE Curve is drawn with real GDP on the horizontal axis and desired aggregate expenditure on vertical axis. It is plotted for a given  price level ❏ We now let price level vary and track the various equilibrium points that occur when an AE function shifts ❏ This is the AD curve that shows the relationship between price level and the equilibrium level of GDP ❏ Plotted with price level on Y axis, real GDP on x axis ❏ Given the value of price level, eq. GDP is determined at the point where AE curve crosses the 45 degree line For any given price level, the AD curve shows the level of real GDP for which desired aggregate expenditure = GDP ❏ 1. A rise in price level causes the AE curve to shift downward and leads to an upward leftward movement along the AD curve, reflecting a fall in eq. GDP ❏ 2. A fall in price level causes the AE curve to shift upward and leads to an downward rightward movement along the AD curve, reflecting a rise in eq. GDP ❏ Why is the AD curve negatively sloped?

❏ A fall in price level leads to a rise in the private sector wealth, which increases desired consumption and thus leads to an increase in eq. GDP ❏ A fall in the price level leads to a rise in net exports and thus leads to an increase in eq. GDP Shifts in AD Curve ❏ 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 down and the AD curve to the left The simple multiplier and the AD curve ❏ 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 ❏ AS refers to the total output of goods and services that firms would like to produce and sell ❏ The AS curve relates the price level to the quantity of output that a firm would like to make under 2 assumptions ❏ The state of technology is constant ❏ The prices of all factors of production are constant The Positive Slope of the AS Curve ❏ The actions of both price-taking and price setting firms cause the price level and the supply of output to be positively related ❏ The AS curve is positively sloped, indicating that firms will provide more aggregate output only at a higher price level Shifts in the AS curve ❏ When input prices change, the AS curve shifts ❏ If prices rise, firms profits at their current levels of output are reduced ❏ Firms respond by: ❏ Maintaining their current level of output in which case they require an increase in the price level ❏ Reducing their level of output if the price level does not change ❏ Both cases, the AS curve shifts upward and leftward ❏ This is a decrease in AS ❏ Vice versa for a fall in input prices ❏ Causes AS curve a downward rightward shift ❏ A deterioration in technology shifts AS up and left ❏ An improvement in technology shifts AS down and right 23.3 Macroeconomic Equilibrium ❏ Macro eq. Occurs ath the intersection of the AD and AS curves and determines the eq. values for real GDP and price level

Changes in the Macroeconomic Equilibrium ❏ Shift in AD curve is called an aggregate demand shock ❏ Rightward shift is an increase in AD, it means that at all price levels expenditure decisions will now be consistent with a higher level of real price level; positive shock ❏ Leftward shift is a decrease in AD; negative shock ❏ Shift in AS curve is called an aggregate supply shock AD shocks cause the price level and real GDP to change in the same direction; both rise with an increase in AD and both fall with a decrease in AD AS shocks cause the price level and GDP to change in different directions; with an increase in supply price level falls and real GDP rises ❏ If an AD shock leads to a change in price level, the ultimate change in real GDP will be less than what is predicted by simple multiplier ❏ A variable price level reduces the value of the multiplier ❏ The effect of any given shift in the 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...