ECN 203 1st Edition Lecture 21Outline of Last Lecture II. Defining Terms a. GDP and Yb. Growth, Recession, DepressionIII. Labor Force and Types of Unemployment Outline of Current Lecture IV. Building the Macro Model a. P, Y, GCEV. Macro Long Run VI. Short Run Aggregate Supply (AS)VII. Aggregate Demand (AD)a. Functional Form VIII. Components of AECurrent Lecture12.0 Building the Macro Model - Macro Picture o Vertical Axis – Price Level (P)o Horizontal Axis – Real GDP (Y) Y f stands for the point along the Y-axis at which the economy is at potential real GDP and full employment. o Two Economic Relationships: Aggregate Demand and Aggregate Supply. The point of intersection of these lines represents the current condition in the macro economy. o When the economy is at the Natural Rate – Y f it is using is resources most efficiently andeffectively. There is no slack. o General Competitive Equilibrium (GCE) o is realized when all of the micro adjustments are completed under our nice assumptions.- The Macro Long Run – not measured in time, but by process o In the Long Run – all micro adjustments are completed under our nice assumptions. These notes represent a detailed interpretation of the professor’s lecture. GradeBuddy is best used as a supplement to your own notes, not as a substitute.o In the Long Run – the Micro economy will be at GCE and the Macro economy will be at Y f. o In the Long Run – the Macro economy is supplying the biggest possible pie Graphically, it is represented as LAS – Long Run Aggregate Supply (LAS)o In the Short Run some of the micro adjustments have not happened.  Particularly, factor prices are constant. - The Short Run Aggregate Supply (AS)o Reflects how, given constant factor prices, increasing Y ultimately puts pressure on the economy as it gets closer to or even exceeds Yf. o In the economy “pressure” creates inflation.  If the GDP supplied grows form Y 1  Y 2 … there is no pressure The economy is just pulling in slack.  No pressure = no inflation o But as Y begins to approach Y f there is less slack and there may be pressure.  Possible pressure = possible inflation o When Y surpasses Y f resources are being stretched which creates pressure.  Pressure = inflation o When Y moves well above Y f … The pressure gets intense  Inflation increases o The AS line traces the pressure created by increasing the production of real GDP, Y When there is plenty of slack, there is no pressure.  But as we take in the slack, that begins to create pressure, which creates inflation.  Although, plenty of slack is not a good thing. - More slack = demand deficient unemployment.  Less slack implies less demand deficient unemp. - So is less slack a good thing? No, the challenge of achieving a healthy economy is to eliminate the slack, to getto Y f without setting off inflation. - Aggregate Demand (AD)o Moves the economy along the AS line o The level of AD determines the current real GDP, Y, and the P. o The real level of AD in the economy depends on how much these individual consumers, enterprises, and gov’t are prepared to spend on how much things cost. o The further to the left the actual Y is the greater unemp. - AD Functional Form: Y = AD (P | AE)o Real GDP Demanded, Y, is a function, AD, of the Price Level, P, given the level of Aggregate Expenditure  Aggregate Expenditure is the nominal amt of money that is spent in the economy. o AD slopes down because for a given level of AE as P rises Y will fall (as P rises the given nominal spending buys less real stuff Y).o AD moves when AE rises of falls because for a given P, more AE buys more real stuff and less AE buys less real stuff.  Ex. Great Depression - AD collapses. Real GDP fell. Unemp skyrocketed and there was deflation. Ex. WW2- AD expanded, Real GDP grew, UNEMP fell, and inflation until gov’t stepped in. - Components of AEo AE = C+I+G-T+X-Mo C = Consumption – the total expenditures individuals make as consumers purchasing things.  More Consumption is simulative. It shifts AD right.  Less consumption is contractionary. It shifts AD left. o I = Investment – total expenditures private enterprises make for items such as new buildings, equipment, and increases inventories.  More investment is simulative, shift AD right. Less investment is contractionary, it shifts AD left.o G = Gov’t Spending – the total amount the gov’t spends on roads, schools, etc. o G-T = the Gov’t Budget Position  (G-T) = 0 is a balanced budget. Neutral, it doesn’t shift AD (G-T) < 0 is a budget surplus. Contractionary, it shifts AD left.  (G-T) > 0 is a budget deficit. Stimulative, shifts AD