Growth Theory Wrap UpAS/AD ModelGrowth Theory Wrap UpAS/AD ModelAggregate DemandElias YannopoulosSeptember 24, 2012Elias Yannopoulos Aggregate DemandGrowth Theory Wrap UpAS/AD ModelGrowth Theory Wrap UpGrowth Theory is focused on the supply side of markets, andincreasing production through growthThe three sources of economic growth are resources,technology and institutionsUpdated Production functionY = A × F (land, labor, capital, institutions)Correlation does not prove causationThe policy prescription is to adopt growth-friendly institutionsand let market forces workElias Yannopoulos Aggregate DemandGrowth Theory Wrap UpAS/AD ModelHistory of MacroeconomicsShort run vs Long run frameworkGrowth theory is part of a long run frameworkBusiness cycle theory is part of the short run theoryMacroeconomics has shifted focus between these twoframeworksBefore the Great Depression, Classical economics (long rungrowth theory) dominatedLaissez Faire - economic policy that involves minimumintervention by government, just enough to protect propertyrights and maintain a stable moneyThis policy did not get much support during the GreatDepression, people did not want to sit and waitKeynes comes along, moves the focus from the long run forcesonto the short run forcesThe long run forces would eventually take over but that didn’thelp the unemployed or the struggling businessesKeynes suggested combating the short run forces, that it takestime for wages and prices to adjust when there is a downturnElias Yannopoulos Aggregate DemandGrowth Theory Wrap UpAS/AD ModelAggregate Supply/Aggregate Demand ModelWith Keynes and the shift in focus to the short run,economist developed business cycle modelsFor this class, the main model is the AggregateSupply/Aggregate Demand ModelAggregate - total; sum ofAggregate Supply - Total Supply of final goods and servicesAggregate Demand - Total Demand for final goods andservicesAS/AD vs Micro Supply and DemandThe AS/AD model is fundamentally different than the MicroSupply and Demand in two important waysThe axis of the Micro model are price and quantity of a singlegood, in Macro the price is the Price Level of all goods andthe quantity is Aggregate DemandThe slopes of the Micro model is a result of substitution andopportunity cost, while those in the Macro model come fromvery different sourcesElias Yannopoulos Aggregate DemandGrowth Theory Wrap UpAS/AD ModelAggregate DemandDemand for GDP from all sourcesConsumption, Investment, Government, and Net ExportsAggregate Demand (AD) curve - a curve that shows how achange in the price level will change aggregate expenditureson all goods and services in an economyThe slope of the AD curve is negative and a result of threeeffects: the wealth effect, the interest rate effect, and theinternational effectElias Yannopoulos Aggregate DemandGrowth Theory Wrap UpAS/AD ModelThe Slope of the AD CurveThe Wealth Effect (also called the Money Wealth Effect)Price level changes affect the real value of wealth, which inturn affects the quantity of ADIncreases in the price level, reduce the real value of wealth ⇒downward sloping AD curveLower wealth ⇒ lower consumptionThe Interest Rate EffectLower wealth ⇒ lower savingsRemember Market for loanable funds (Ex: Graph)↓ Savings ⇒↑ R ⇒ Quantity of investmentThe International EffectThe price level is for that of the economy (For us that is theprice level in the US)Changes in the price level affect the relative prices of goodscompared to international goods↓ P ⇒ Relatively Cheaper goods ⇒↑ XElias Yannopoulos Aggregate DemandGrowth Theory Wrap UpAS/AD ModelShifts in ADRemember Quantity Demanded vs Demand, this still appliesfor ADWhat we just finished was how price level changes impactquantity demanded, now we are talking about what causeshifts in DemandFactors that shift Aggregate DemandReal WealthExpected IncomeExpected Future PricesForeign Income and WealthValue of the DollarGovernment Control of the AD curve, Spending and TaxesElias Yannopoulos Aggregate
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