Chapter 8 Aggregate Demand and Aggregate SupplyChapter OutlineYou Are HereAggregate DemandFigure 1 Aggregate DemandWhy Aggregate Demand is Downward SlopingAggregate SupplyFigure 2 The Aggregate Supply CurveThe Ranges of ASVariables that Shift Aggregate DemandDeterminants of ADFigure 3 AD IncreasesFigure 4 AD DecreasesVariables that Shift ASDeterminants of ASFigure 5 Increase in ASFigure 6 Decrease in ASCauses of InflationGovernment Influence: Aggregate DemandGovernment Influence: Aggregate SupplyChapter 8Aggregate Demand and Aggregate SupplyCopyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin8-2Chapter Outline•Aggregate Demand•Aggregate Supply•Shifts in Aggregate Demand and Aggregate Supply•Causes of Inflation•Supply-Side Economics•How the Government can Influence (but probably not control) the economy8-3You Are Here8-4Aggregate Demand•Aggregate Demand: the amounts of real domestic output which domestic consumers, businesses, governments, and foreign buyers collectively will desire to purchase at each possible price level8-5Figure 1 Aggregate DemandRGDPPIAD8-6Why Aggregate Demand is Downward Sloping•Real Balances Effect–Because higher prices reduce real spending power, prices and output are negatively related.•Foreign Purchases Effect–When domestic prices are high, we will export less to foreign buyers and we will import more from foreign producers. Therefore higher prices leads to less domestic output.•Interest Rate Effect–higher prices lead to inflation which leads to less borrowing and a lowering of RGDP8-7Aggregate Supply•Aggregate Supply: the level of real domestic output available at each possible price level8-8Figure 2 The Aggregate Supply CurveRGDPPIKeynesian RangeClassical Range Intermediate RangeAS8-9The Ranges of AS•Keynesian Range–Large amounts of unemployment make it so that increases in aggregate demand have no affect on wages or prices.•Classical Range–Full employment makes it so that increases in aggregate demand only increase wages or prices.•Intermediate Range–Some sectors of the economy reach full employment more quickly than others.8-10Variables that Shift Aggregate Demand•Taxes•Interest Rates•Confidence•Strength of the Dollar•Government Spending8-11Determinants of ADVariable GDP Component C,I,G,XEffect of an increase on ADEffect of a decrease on ADTaxes C,I Decrease soAD <=Increase soAD =>Interest RatesC,I Decrease soAD <=Increase soAD =>Confidence C,I Increase soAD =>Decrease soAD <=Strength of the DollarX (exports-imports)Decrease soAD <=Increase soAD =>Government SpendingG Increase soAD =>Decrease soAD <=8-12Figure 3 AD IncreasesAD’ASADRGDPPIPI*RGDP*PI’RGDP’8-13Figure 4 AD DecreasesAD’ASADRGDPPIPI*RGDP*PI’RGDP’8-14Variables that Shift AS•Input Prices•Productivity•Government Regulation8-15Determinants of ASVariableEffect of an Increase on ASEffect of an Decrease on ASInput Prices Decrease soASIncrease so ASProductivityIncrease so ASDecrease soASGovernment RegulationDecrease soASIncrease so AS8-16Figure 5 Increase in ASASADRGDPPIPI*RGDP*AS’PI’RGDP’8-17Figure 6 Decrease in ASRGDPASADPIPI*RGDP*AS’PI’RGDP’8-18Causes of Inflation•Demand Pull Inflation: inflation caused by an increase in aggregate demand •Cost Push Inflation: inflation caused by a decrease in aggregate supply8-19Government Influence: Aggregate Demand•Government can influence economic activity with aggregate demand side policies affecting:–Taxes–Government Spending–Interest Rates8-20Government Influence: Aggregate Supply•Government can influence economic activity with aggregate supply side policies affecting–input costs (labor and wage)–reducing regulation–Increase incentives to •Work•Take Risks•The actions are call Supply Side
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