Aggregate
Demand
· There are two parts
to a shift in ad
· Shifts in aggregate
demand:
o
A
change in c, Ig, and/or Xn
o
A
multiplier effect that produces a greater change than the original change in
the 4 components
· Increase = shifts to
the right
· Decrease = shift to
the left
Determinants of AD:
o
Consumption
o
Household
spending is affect by:
§ Consumer wealth
· More wealth= more
spending (AD shifts ->)
· Less wealth= less
spending (AD shifts <-)
§ Consumer expectations
· Positive expectations
= more spending (AD ->)
· Negative expectation
= less spending (AD <-)
§ Household
indebtedness
· Less debt = more
spending
· More debt = less
spending
§ Taxes
· Less taxes = more
spending
· More taxes = less
spending
Gross private investment
·
Investment
spending is a sensitive to:
o the real interest rate
§ Lower real interest
rate = more investment (AD ->)
§ Higher real interest
rate = less investment (AD<-)
o Expected returns
§ Higher expected
returns = more investment
§ Lower expected
returns = less investment
§ Especial returns are
influenced by
§ Expectation of future
profitability
· Technology
· degree of excess
capacity (Existing stock of capital)
Gov’t spending
·
More
gov’t spending (AD->)
·
Less
gov’t spending (AD<-)
Net exports
·
Nets
exports are sensitive to:
o
Exchange
rate (international value of $)
§ Strong $ = more
imports and fewer exports (AD<-)
§ Weak $ = fewer
imports and more exports (AD->)
o
Relative
income
§ Strong foreign
Economies = more exports
§ Week foreign
economies = less exports
Aggregate Supply
§ Long Run Aggregate Supply (LRAS) - the
period of time where input prices are completely flexible and adjust to changes
in the price level.
o
The
level of real GDP supplied is independent of price level.
o
It
marks the level of full employment in the economy. (FE, Yf, Y' = full
employment)
o
Analogous
to PPC
o
Since
input prices are flexible in long run, changes in price level do not change
firms real profits and therefore don't change firms level of output.
o
LRAS
is vertical at the economy's level of full employment.
§ Short Run Aggregate Supply (SRAS) -
Period of time where input prices are sticky and don't adjust to changes in the
price level
o
The
level o real GDP supplied is directly related to the price level.
o
Input
prices are sticky in the short run, the SRAS is upward slopping.
o
An
increase in SRAS is seen as a shit to the right and decrease to the left
o
The
key to understanding shifts in SRAS is per unit cost production
o
Per
unit cost production = total input cost
Determinants
of SRAS: (affect unit production cost)
1. Input Prices
a. Domestic Resource
Prices:
i. wages (75% of all business
costs)
ii. cost of capital
iii. raw materials
(commodity prices)
b. Foreign Resource
Prices
i. Strong money: lower
foreign resource prices
ii. Weak money: higher
foreign resource prices
c. Market Power: Monopolies
and cartels that control the price of those resources
d. Increase in resource
prices: SRAS <----
e. Decrease in resource
prices: SRAS ---->
2. Productivity
a. Productivity = total
output/total inputs
i. More productivity =
lower unit production cost --->
ii. Lower productivity =
higher unit production cost <----
3. Legal - Institutional
Environment:
a. Taxes and subsidies
i. Taxes (money to
government) on business increase per unit production cost, shits SRAS <--
ii. Subsidies (money from
government) to business reduce per unit production cost, shifts SRAS -->
b. Government
Regulation: creates a cost o compliance = SRAS <--
c. Deregulation: reduces
compliance cost = SRAS -->
Full Employment – Equilibrium
exists where AD interests SRAS and LRAS at the same point.
Recessionary Gap - exists when
equilibrium occurs below full employment output.
-AD decrease shifts to
the left
Inflationary Gap- exists when
equilibrium occurs
beyond full employment output.
-AD increases
shifts to the right
Interest Rates and
Investments Demand
§ Money spent on
expenditures on:
o
New
plants ( factories )
o
Capital
equipment ( machinery )
o
Technology
( hardware and software )
o
New
homes
o
Inventories
( goods sold by producers )
§ How do a business
make investment decisions?
o
Cost
/ Benefits Analysis
§ How does a business
determine benefits?
o
Expected
rate of return
§ How does a business
count the cost?
o
Interest
Cost
§ How does a business
determine the amount of investment they undertake?
o
Compare
expected rate of return to interest cost
§
If
expected return > interest cost, then invest
§
If
expected return < interest cost, do not invest
Real ( r% ) vs.
Nominal ( i% ) (pie)inflation
§ What’s the
difference?
o
Nominal
is observable rate of interest. Real subtracts out inflation (pie%) and only
known ex post facto.
§ How to compute the
real interest rate
o
r%=
i% - pie%
§ What determines cost
of an investment decision?
o
Real
interest rate ( r%)
§ What is the shape of
investment demand slope?
o
Downward
sloping
§ Why?
o
When
interest rates are high, few investments are profitable. When interest rate are
low, more investments are profitable.
The
Investment Demand Curve
§ Cost of production
o
lower
cost shifts ID --.
o
Higher
cost shifts ID <--
§ Business Taxes
o
lower
business taxes shift ID -->
o
higher
business taxes shift ID <--
§ Technological Change
o
New
technology -->
o
Lack
of technology <--
§ Stock of Capital
o
If
an economy is low on capital then ID shifts -->
o
If
it has much capital then ID shifts <--
§ Expectations
o
positive
expectations shift ID -->
o
negative
expectations shift ID <--
LRAS: represents
a point on an economics production possibilities curve and it is a vertical
line at an output level that represents the quantity of goods and services a
nation can produce over a sustained period using all of its productive
resources as efficiently as possible.
o
Always
at full employment
o
Does
not change as price level changes
o
Shifts
outward if there is a change in technology, resource, or there is economic
growth.
