Lecture 17 Flashcards
Aggregate demand curve
Aggregate demand curve: the relationship between the aggregate price level and the quantity of aggregate ouput demanded by households, businesses, the govermen, and the rest of the world
Aggregate Price level:
Aggregate Price level: The aggregates price level refers to the average level of prices in an economy. It is a measure of the overall price level of goods and services produced in an economy over a period of time.
Why, then, does a rise in the aggregate price level lead to a fall in the quantity of all domestically produced final goods and services demanded?
Why do aggregate expenditures increase when the price level falls?
1) The wealth affect) : A higher aggregatr price level reduces the purchasing power of households and reduces consumer spending
f the aggregate price level were to rise by 25%, what used to cost $5,000 would now cost $6,250,
2) The interst rate effect: a higher aggregate price level makes households hold more money and leads to a rise in interest rates (and a fall in investment spending and consumer spending)
When price level goes down, interest rates will fall, and so people will go buy more.
o purchase the same basket of goods and services as before, people and firms now need to hold more money. So, in response to an increase in the aggregate price level, the public tries to increase its money holdings, either by drawing down its savings in bank accounts, by borrowing more, or by selling assets such as bonds. This reduces the funds available for lending to other borrowers and drives interest rates up.
Factors that shift aggregate demand:
1) Changes in expecations
- When consumers and firms become more optimistic aggregate demand increase how ever when consumers and firms beoce more pessistmic aggregate demand decreases
2) Chanes in wealth:
- When the real value of households asset rises: aggregate demand increases, however when the real value of households assets fall aggregate demand decreases
3) Size of the existing stock of physical capital
- When the exisiting stock of physical capital is relatively small aggregate demand increases, and when exisiting stock of physical capital is relatively large aggregate demand decreases.
- Would you want to be the first power plant in a country or make the 100th in a country.
4) Fiscal Policy:
- When the government increases spending or cut taxes aggregate demand increases, however When the government decreases spending or increases taxes aggregate demand decreases
5) Monetary Policy:
- When the central bank increases the quantity of money aggregate demand increases , When the central bank decreases the quantity of money aggregate demand decreases
Size of the existing stock of physical capital” refers to
Size of the existing stock of physical capital” refers to the quantity and quality of the tangible assets used in production within an economy at a given point in time.
Does a change in wealth move us along the Aggregate demand curve (wealth effect) or shift it?
A: It depends on the source of the change in wealth
- If it’s a change in price level that affects our wealth, it’s a movement along the AD. Example rapid inflation shrinks our wealth
- If it’s a change in something else that affects our wealth, it’s a shift in the AD. Example the housing market crashes
Why does aggregate demand decrease (go down)?
The curve is downward sloping due to the wealth effect of a change in the aggregate price level and the interest rate effect of a change in the aggregate price level.
When we consider movements up or down the aggregate demand curve, weʼre considering a simultaneous change in the prices of all final goods and services. Furthermore, changes in the
MI − X + G + I + C
composition of goods and services in consumer spending arenʼt relevant to the aggregate demand curve: if consumers decide to buy fewer clothes but more cars, this doesnʼt necessarily change the total quantity of final goods and services they demand.
The aggregate supply curve shows
The aggregate supply curve shows the relationship between the
aggregate price level and the quantity of aggregate output
supplied in the economy
Why does the SRAS curve slope upward?
1) Nominal wages are sticky in the short run.
2) is upward sloping because a higher aggregate price level leads to higher profit per unit of output and higher aggregate output given fixed nominal wages
– Nominal wage: the dollar amount of the wage paid
– Sticky wages: nominal wages that are slow to fall even in the
face of high unemployment and slow to rise even in the face of
labor shortages
. Itʼs important to note, however, that nominal wages cannot be sticky forever: ultimately, formal contracts and informal agreements will be renegotiated to take into account changed economic circumstances.
How dos the change in the aggregate price level affect quanttiy of aggregate ouput in the long run
changes in the aggregate price level do not change the quantity of aggregate output supplied in the long run. Thatʼs because changes in the aggregate price level, which is composed of prices of final goods and services, will be accompanied by equal proportional changes in all input prices, including nominal wages.
The long-run aggregate supply curve
The long-run aggregate supply curve shows the relationship between the aggregate price level and the quantity of aggregate output supplied that would exist if all prices, including nominal wages, were fully flexible.
In perfect/Imperfect compeitivve markets what price do they choose?
In perfectly competitive markets, producers take prices as given; in imperfectly competitive markets, producers have some ability to choose the prices they charge.
aggregate price level falls, which means that the price received by the typical producer of a final good or service falls. Because many production costs are fixed in the short run, production cost per unit of output doesnʼt fall by the same proportion as the fall in the price of output. So the profit per unit of output declines, leading perfectly competitive producers to reduce the quantity supplied in the short run.
aggregate price level rises. As a result, the typical producer receives a higher price for its final good or service. Again, many production costs are fixed in the short run, so production cost per unit of output doesnʼt rise by the same proportion as the rise in the price of a unit. And since the
typical perfectly competitive producer takes the price as given, profit per unit of output rises and output increases.
Now consider an imperfectly competitive producer that is able to set its own price. If there is a rise in the demand for this producerʼs product, it will be able to sell more at any given price. Given stronger demand for its products, it will probably choose to increase its prices as well as its output, as a way of increasing profit per unit of output. In fact, industry analysts o en talk about variations in an industryʼs pricing power: when demand is strong, firms with pricing power are able to raise prices—and they do.
Conversely, if there is a fall in demand, firms will normally try to limit the fall in their sales by cutting prices
Long run aggregate supply curve:
shows the relationship between the aggregate price level and the quantity of aggregate output supplied that holds when all prices, including nominal wages, are fully flexible.
Potential output
otential Output: refers to the maximum sustainable level of (GDP) that an economy can produce over the long term without causing inflationary pressures. It represents the economy’s productive capacity when all resources (capital, labor, technology) are fully utilized, and all factors of production are efficiently employed.
Potential output is the level of real GDP the economy would produce if all prices, including nominal wages, were fully flexible.
The long-run aggregate supply curve is vertical at potential output.
How does the long run aggregat supply ucrve look like
The long-run aggregate supply curve is vertical at potential output.
