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1、1Chapter 5Aggregate Supply and DemandItem ItemItemEtc.McGraw-Hill/IrwinMacroeconomics,10e 2008 The McGraw-Hill Companies,Inc.,All Rights Reserved.2IntroductionThe last few chapters have detailed models of long run economic growth now turn to short run fluctuations in the economy that constitute the
2、business cycleThe AS/AD model is the basic macroeconomic tool for studying output fluctuations and the determination of the price level and the inflation rateCan be used to explain how the economy deviates from a path of smooth growth over time,and to explore the consequences of government policies
3、intended to reduce unemployment and output fluctuations,and maintain stable prices3AS and ADAggregate supply curve describes,for each given price level,the quantity of output firms are willing to supplyUpward sloping since firms are willing to supply more output at higher pricesAggregate demand curv
4、e shows the combinations of the price level and the level of output at which the goods and money markets are simultaneously in equilibriumDownward sloping since higher prices reduce the value of the money supply,which reduces the demand for outputIntersection of AS and AD curves determines the equil
5、ibrium level of output and price level4AS,AD,and EquilibriumAS and AD intersect at point E in Figure 5-1 Equilibrium:AS=ADEquilibrium output is Y0 Observed level of output in the economy at particular point in timeEquilibrium price level is P0Observed price level in the economy at particular point i
6、n timeInsert Figure 5-1 here5AS,AD,and EquilibriumShifts in either the AS or AD schedule results in a change in the equilibrium level of prices and outputIncrease in AD increase in P and YDecrease in AD decrease in P and YIncrease in AS decrease in P and increase in YDecrease in AS increase in P and
7、 decrease in YInsert Figure 5-2 hereFigure 5-2 illustrates an increase in AD resulting from an increasein money supply.6AS,AD,and Equilibrium The amount of the increase/decrease in P and Y after a shift in either aggregate supply or aggregate demand depends on:1.The slope of the AS curve2.The slope
8、of the AD curve3.The extent of the shift of AS/ADInsert Figure 5-3 hereFigure 5-3 shows the result of anadverse AS shock:AS Y,P7Classical Supply CurveThe classical supply curve is vertical,indicating that the same amount of goods will be supplied,regardless of price Figure 5-4(b)Based upon the assum
9、ption that the labor market is in equilibrium with full employment of the labor forceThe level of output corresponding to full employment of the labor force=potential GDP,Y*Insert Figure 5-4 hereLong run version of the AS curve8Classical Supply CurveY*grows over time as the economy accumulates resou
10、rces and technology improves AS curve moves to the right The growth theory models described in earlier chapters explain the level of Y*in a particular periodY*is“exogenous with respect to the price level”illustrated as a vertical line since graphed in terms of the price levelInsert Figure 5-5 here9K
11、eynesian Supply CurveThe Keynesian supply curve is horizontal,indicating firms will supply whatever amount of goods is demanded at the existing price level Figure 5-4(a)Since unemployment exists,firms can obtain any amount of labor at the going wage rate Since average cost of production does not cha
12、nge as output changes,firms willing to supply as much as is demanded at the existing price levelInsert Figure 5-4 here,again10Keynesian Supply CurveIntellectual genesis of the Keynesian AS curve is found in the Great Depression,when it seemed firms could increase production without increasing P by p
13、utting idle K and N to workAdditionally,prices are viewed as“sticky”in the short run,or firms are reluctant to change prices and wages when demand shiftsInstead firms increase/decrease output in response to demand shift=flat AS curve in the short run ShortShort run version of the AS curverun version
14、 of the AS curve11Frictional Unemployment and the Natural Rate of UnemploymentTaken literally,the classical model implies that there is no involuntary unemployment everyone who wants to work is employedIn reality there is some unemployment due to frictions in the labor market(Ex.Someone is always mo
15、ving and looking for a new job)The unemployment rate associated with the full employment level of output is the natural rate of unemploymentNatural rate of unemployment is the rate of unemployment arising from normal labor market frictions that exist when the labor market is in equilibrium12AS and t
16、he Price Adjustment MechanismAS curve describes the price adjustment mechanism within the economyFigure 5-6 shows the SRAS curve in black and the LRAS in green,and the adjustment from the SR to the LRThe AS curve is defined by the equation:(1)where Pt-1 is the price level next period Pt is the price
17、 level todayY*is potential outputInsert Figure 5-6 here13AS and the Price Adjustment Mechanism (1)If output is above potential(YY*),prices will increase and be higher next periodIf output is below potential(YY*,price will be higher(AS shifting up)by t=1Process continues until Y=Y*Insert Figure 5-6 h
18、ere15AS and the Price Adjustment Mechanism (1)The speed of the price adjustment mechanism is controlled by the parameter If is large,AS moves quickly(the counter clock-wise rotations in Figure 5-6(a)If is small,prices adjust slowly is of importance to policy makers:If is large,the AS mechanism will
19、return the economy to Y*relatively quicklyIf is small,might want to use AD policy to speed up the adjustment processInsert Figure 5-6 here16AD Curve and Shifts in ADAD shows the combination of the price level and level of output at which the goods and money markets are simultaneously in equilibriumS
20、hifts in AD due to:1.Policy measuresChanges in G,T,and MS2.Consumer and investor confidenceInsert Figure 5-8 hereFigure 5-8 shows an outward shift in AD resulting from an increase in themoney supply.17AD Relationship Between Output and PricesKey to the AD relationship between output and prices is th
21、e dependency of AD on real money supplyReal money supply=value of money provided by the central bank and the banking systemReal money supply is written as ,where is the nominal money supply,and P is the price level AND For a given level of ,high prices result in low OR high prices mean that the valu
22、e of the number of available dollars is low and thus a high P=low level of AD Inverse relationship between P and Y downward sloping AD curve18AD and the Money MarketFor the moment,ignore the goods market and focus on the money market and the determination of ADThe quantity theory of money offers a s
23、imple explanation of the link between the money market and ADThe total number of dollars spent in a year,NGDP,is P*YThe total number of times the average dollar changes hands in a year is the velocity of money,VThe central bank provides M dollars The fundamental equation underlying the quantity theo
24、ry of money is the quantity equation:(2)19AD and the Money Market (2)If the velocity of money is assumed constant,equation(2)becomes ,and is an equation for the AD curveFor a given level of M,an increase in Y must be offset by a decrease in P,and vice versaInverse relationship between Y and P as ill
25、ustrated by downward sloping AD curveAn increase in M shifts the AD curve upward for any value of YIllustrated in Figure 5-820Changes in the Money Stock and ADAn increase in the nominal money stock shifts the AD schedule up exactly in proportion to the increase in nominal moneySuppose corresponds to
26、 AD and the economy is operating at P0 and Y0If money stock increases by 10%to ,AD shifts to AD the value of P corresponding to Y0 must be P=1.1P0Therefore real money balances and Y are unchanged Insert Figure 5-8 here,again21AD policy and the Keynesian Supply CurveFigure 5-9 shows the AD schedule a
27、nd the Keynesian supply scheduleInitial equilibrium is at point E(AS=AD)Suppose an aggregate demand policy increases ADto ADThe new equilibrium point,E,corresponds to the same price level,and a higher level of output(employment is also likely to increase)Insert Figure 5-9 here22AD policy and the Cla
28、ssical Supply CurveIn the classical case,AS schedule is vertical at FE level of outputUnlike the Keynesian case,the price level is not given,but depends upon the interaction between AS and ADSuppose AD increases to AD:At the original price level,spending would increase to E BUT firms can not obtain
29、the N required to meet the increased demandAs firms hire more workers,wages and costs of production increase,and firms must charge higher priceMove up AS and AD curves to E where AS=ADInsert Figure 5-10 hereRESULT:Increase in AD resultsin higher prices,but not output23AD policy and the Classical Sup
30、ply CurveThe increase in price from the increase in AD reduces the real money stock,and leads to a reduction in spendingThe economy only moves up AD until prices have risen enough,and M/P has fallen enough,to reduce total spending to a level consistent with full employment this is true at E,where AD
31、=AS Insert Figure 5-10 here24Supply Side EconomicsSupply side economics focuses on AS as the driver in the economySupply side policies are those that encourage growth in potential output shift AS to rightSuch policy measures include:Removing unnecessary regulationMaintaining efficient legal systemEn
32、couraging technological progressPoliticians use the term supply side economics in reference to the idea that cutting taxes will increase AS enough that tax collections will actually increase,rather than fall 25Supply Side EconomicsCutting tax rates has an impact on both AS and ADAD shifts to AD due
33、to increase in disposable income Shift is relatively large compared to that of the ASAS shifts to AS as the incentive to work increasesIn short run,economy moves from E to E:GDP increases,tax revenues fall proportionately less than tax cut(AD effect)In the LR,economy moves to E as AS curve shifts to
34、 right:GDP is higher,but by a small amount,tax collections fall as the deficit risesInsert Figure 5-11 here26Supply Side EconomicsSupply side policies are useful,despite previous exampleOnly supply side policies can permanently increase outputDemand side policies are useful for short run resultsMany
35、 economists support cutting taxes for the incentive effect,but with a simultaneous reduction in government spending tax collections fall,but the reduction in government spending minimizes the impact on the deficitThe deficit is the excess of government expenditures over tax revenues.27AS and AD in t
36、he Long RunIn the LR,AS curve moves to the right at a slow,but steady paceMovements in AD over long periods can be large or small,depending largely on movements in money supplyFigure 5-12 shows a set of AS and AD curves for the period 1970-2000Movements in AS slightly higher after 1990Big shifts in AD between 1970 and 1980Prices increase when AD moves out more than ASOutput determined by AS,while prices determined by the relative shifts in AS and ADInsert Figure 5-12 here28