Macroeconomics chapter 12 highlights PDF

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The aggregate demand shows the amount of a nation’s output (real GDP) that buyers collectively desire to purchase at each possible price level. The relationship between the price level and the amount of real GDP demanded is inverse or negative. The aggregate demand curve is downwardly sloping b/c of the interest-rate, real-balance, & foreign-purchases effect. The Interest-rate effect suggests that an increase (decrease) in the price level will increase (decrease) the demand for money, increase (decrease) interest rates, and decrease (increase) consumption and investment spending. The real-balances effect indicates that a higher (lower) price level will decrease (increase) the real value of many financial assets and therefore reduce (raise) spending. The foreign-purchases effect suggests that an increase (decrease) in the U.S. price level relative to other countries will increase (decrease) U.S. imports and decrease (increase) U.S. exports. Factors that would shift the aggregate demand curve are changes in (i) consumer spending, (ii) investment spending, (iii) government spending, and (iv) net export spending. Review the determinants of consumer spending, investment spending, and net export spending on pages 246 and 247 on our textbook. Changes in aggregate demand are subject to the multiplier. Therefore, say, the size of the economy’s multiplier is 4 and there is a $10 billion increase in investment spending. This will increase aggregate demand by $40 billion.

Aggregate supply is a 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. The relationship depends on the time horizon in the economy. There are three different time horizons – (i) immediate short run when both input & output prices are fixed, (ii) short run when input prices are fixed but output prices can vary, and (iii) long run when both input and output prices can vary. The immediate short run supply curve is horizontal (or perfectly elastic). Thus, whenever the aggregate demand curve shifts in the immediate short run, only the economy’s output changes but not the price level. See Figure 12.3 The aggregate supply curve is positively sloped in the short-run b/c with input prices fixed, changes in the price level will raise or lower real firm profits. Thus, there is a positive relationship between the price level and the amount of real output that firms will offer for sale. The AS curve is relatively flat below the full-employment output b/c unemployed resources and unused capacity allow firms to respond to price-level rises with large increases in real output. It is relatively steep beyond the full-employment output b/c resource shortages and capacity limitations make it difficult to expand real output as the price level rises. See Figure 12.4 Per-unit production cost = total input cost / units of output

The aggregate supply curve is vertical at the full-employment level of real GDP b/c in the long run wages and other input prices rise and fall to match changes in the price level. So price-level changes do not affect firms’ profits and thus they create no incentive for firms to alter their output. See Figure 12.5 Factors that shift the short-run aggregate supply curve are (i) changes in input prices – including domestic resource prices & imported resource prices, (ii) changes in productivity, and (iii) changes in legal-institutional environment – including business taxes/subsidies & government regulation. Productivity = total output / total inputs Please review Equilibrium in the AD-AS Model section starting on page 253 through 258 on our text book. See Figure 12.7, Figure 12.8, Figure 12.9, Figure 12.10 Prices and wages tend to be flexible upward but inflexible downward. Real output takes the brunt of declines in aggregate demand in the U.S. economy b/c the price level tends to be downwardly rigid in the immediate short run. There are several reasons for this downward price stickiness, (i) fear of price wars – some large firms may be concerned that if they reduce their price, rivals not only will match their price cuts but may retaliate by making even deeper cuts, (ii) menu costs – firms that think a recession will be relatively short-lived may be reluctant to cut their prices since doing so could generate additional costs to the firm, (iii) wage contracts – since large parts of the labor force work under contracts prohibiting wage cuts for the duration of the contract, firms cannot profit from cutting their product

prices, (iv) morale, effort, and productivity – lower wages might impair worker morale and work effort, thereby reducing productivity, and (v) minimum wage – firms paying those wages cannot reduce that wage rate when aggregate demand declines. Efficiency wages are defined as wages that elicit maximum work effort and thus minimize labor costs per unit of output....