ECO 2013 Principles of Macroeconomics Chapter 10 Dynamic Change Economic Fluctuations and the AD AS Model 5 Learning Goals 1 Examine the factors that shift aggregate demand Chapter heading Factors that Shift Aggregate Demand List the factors that increase aggregate demand 1 Increase in real wealth 2 Decrease in the real interest rate 3 Optimism about the future direction of the economy 4 Expectation of higher inflation 5 A rapid increase in income of trading partners 6 US dollar depreciates List the factors that decrease aggregate demand 1 Decrease in real wealth 2 Decrease in real interest rate 3 Pessimism about future direction of economy 4 Expectation of lower inflation 5 Rapid decrease in income of trading partners 6 US dollar appreciates Remember These factors are really categories of changes in the economy The actual economy has many more specific variables that change which influence aggregate demand 2 Examine the factors that shift short run and long run aggregate supply Chapter heading Shifts in Aggregate Supply Key terms Productivity Average output produced per worker during a specific time period Usually measured in terms of output per hour worked Supply shock Surprise occurrences that temporarily increase or decrease current output List the factors that increase long run aggregate supply 1 An improvement in technology 2 Increase in resource base 3 Institutional changes that increase productivity or efficiency List the factors that decrease long run aggregate supply 1 Reductions in technology 2 Decrease in resource base 3 Institutional changes that decrease productivity or efficiency List the factors that increase short run aggregate supply 1 A reduction in resource prices 2 Decrease in the expected rate of inflation 3 Positive supply shocks List the factors that decrease short run aggregate supply 1 Increase in resource prices 2 Increase in the expected rate of inflation 3 Negative supply shocks Remember These factors are really categories of changes in the economy The actual economy has many more specific variables that change which influence aggregate supply 3 Analyze the impact of unanticipated changes in aggregate demand and short run aggregate supply Chapter heading Unanticipated Changes and Market Adjustments Choose one factor that increases aggregate demand Describe the process in which the economy will return to long run equilibrium A factor that could increase AD is a stock market boom This would cause the AD curve to shift rightward prices will rise in the short run and output will increase temporarily exceeding full employment capacity However over time prices in resource markets including the labor market will rise as the result of the strong demand The higher resource prices will mean higher production costs which will reduce aggregate supply shifting the SRAS curve to the left In the long run a new equilibrium will emerge at a higher price level and an output consistent with the economy s sustainable capacity The increase in AD will expand output only temporarily Choose one factor that decreases aggregate demand Describe the process in which the economy will return to long run equilibrium An unanticipated decrease in AD could result from decision makers becoming more pessimistic about the future of the economy This will cause the AD curve to shift leftward In the short run output will decline and there will be a lower price level Temporarily profit margins will decline output will fall and unemployment will rise above its natural rate In the long run weak demand and excess supply in the resource market will lead to lower wages and resource prices This will lower production costs leading to an expansion in SRAS shifting the SRAS curve rightward Choose one factor that increases short run aggregate supply Describe the process in which the economy will return to long run equilibrium A factor that could increase SRAS are favorable supply shocks such as good weather conditions for crops or a temporary fall in the world price of oil This will cause the SRAS curve to shift to the right and will lead to a lower price level and an increase in current GDP Because the favorable conditions will come to an end SRAS curve will return to its original position and long run equilibrium will be restored Choose one factor that decreases short run aggregate supply Describe the process in which the economy will return to long run equilibrium Factors that would cause a decrease in SRAS would be adverse supply shocks such as a drought or higher oil prices Higher resource prices will shift the SRAS curve to the left In the short run the price level will rise and output will decline What happens in the long run depends on whether the reduction in the supply of resources is temporary or permanent If it is temporary resource prices will fall in the future permitting the economy to return to its initial equilibrium If it is permanent the production capacity of the economy will shrink shifting LRAS to the left creating a new equilibrium 4 Consider whether market forces will return the economy to equilibrium without government intervention Chapter heading Unanticipated Changes Recessions and Booms What are the two forces that underlie the self correcting mechanism 1 Changes in resource prices will help direct an economy toward equilibrium 2 Changes in real interest rates help stabilize aggregate demand and redirect economic fluctuations
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