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aggregate demand
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total amount of real output (real GDP) that consumers, firms, the government and foreigners are willing and able to pay at each possible price level, over a particular time period, ceteris paribus
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aggregate demand (AD) curve
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shows relationship between total amount of real output demanded by four components and price level over a particular time period, ceteris paribus.
*downward-slope indicative of negative relationship between price level and aggregate output demanded
*downward-slope indicative of negative relationship between price level and aggregate output demanded
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the aggregate demand (AD) curve
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average over the prices of all goods/services in economy
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price level
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demand of consumers ©
demand of businesses (firms) (I)
demand of government (G)
demand of foreigners for exports (X) minus demand for imports (M) (X−M or net exports)
demand of businesses (firms) (I)
demand of government (G)
demand of foreigners for exports (X) minus demand for imports (M) (X−M or net exports)
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components of aggregate expenditure
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wealth effect
interest rate effect
international trade effect
interest rate effect
international trade effect
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reasons for downward slope of aggregate demand curve
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changes in price level affect real value of wealth (=value of assets)
increased price level → decreased real value of wealth → people feel worse off + cut back on spending → less output demanded → upward movement along AD curve + vice versa
increased price level → decreased real value of wealth → people feel worse off + cut back on spending → less output demanded → upward movement along AD curve + vice versa
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wealth effect
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changes in price level affect rates of interest
increased price level → consumers + firms need more money to purchase/transact → increased demand for money → increased interest rate → increased cost of borrowing → decreased consumer purchases financed by borrowing + decreased investment spending by firms that borrow
∴ increased price level = fall in quantity of output demanded = upward movement along AD curve + vice versa
increased price level → consumers + firms need more money to purchase/transact → increased demand for money → increased interest rate → increased cost of borrowing → decreased consumer purchases financed by borrowing + decreased investment spending by firms that borrow
∴ increased price level = fall in quantity of output demanded = upward movement along AD curve + vice versa
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interest rate effect
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changes in price level affect international trade
increased domestic price level, ceteris paribus:
→ exports more expensive to foreign buyers → decreased demand for exports
→ imports relatively cheaper for domestic buyers → increased demand for imports
∴ fall in net exports = fall in quantity of output demanded = upward movement along AD curve + vice versa
increased domestic price level, ceteris paribus:
→ exports more expensive to foreign buyers → decreased demand for exports
→ imports relatively cheaper for domestic buyers → increased demand for imports
∴ fall in net exports = fall in quantity of output demanded = upward movement along AD curve + vice versa
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international trade effect
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consumers / possible buyers
single product / aggregate output
price / price level
different explanations of downward slope: diminishing marginal benefit / wealth effect, etc.
different horizontal axis variable: quantity of single good / quantity of total output (real GDP) = total income
single product / aggregate output
price / price level
different explanations of downward slope: diminishing marginal benefit / wealth effect, etc.
different horizontal axis variable: quantity of single good / quantity of total output (real GDP) = total income
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how aggregate demand differs from microeconomic demand
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factor other than price level affecting aggregate demand causes shift of AD curve
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determinant of aggregate demand
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aggregate demand increases = for any price level, a larger amount of real GDP is demanded
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rightward shift of aggregate demand curve
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aggregate demand decreases = for any price level, a smaller amount of real GDP is demanded
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leftward shift of aggregate demand curve
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changes in consumer confidence
changes in interest rates (monetary policy)
changes in wealth
changes in personal income taxes (fiscal policy)
changes in level of household indebtedness
changes in interest rates (monetary policy)
changes in wealth
changes in personal income taxes (fiscal policy)
changes in level of household indebtedness
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causes of changes in consumption spending
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consumer confidence = measure of how optimistic consumers are about future income / future of economy
optimism re. income / economy = spend more on goods/services = rightward shift of AD curve + vice versa
*governments use surveys to predict consumer spending
optimism re. income / economy = spend more on goods/services = rightward shift of AD curve + vice versa
*governments use surveys to predict consumer spending
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changes in consumer confidence
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consumer spending financed by borrowing is affected by interest rates
∴ increased interest rates → borrowing more expensive → lower consumer spending → leftward shift of AD curve + vice versa
*monetary policy can change interest rates
∴ increased interest rates → borrowing more expensive → lower consumer spending → leftward shift of AD curve + vice versa
*monetary policy can change interest rates
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changes in interest rates (consumer spending)
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increased consumer wealth → consumers feel wealthier → increased consumer expenditure → rightward shift of AD curve + vice versa
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changes in wealth
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personal income taxes = taxes paid by households on their incomes
disposable income = income left after after payment of personal income taxes
∴ increased personal income tax → decreased disposable tax → decreased consumer spending → leftward shift of AD curve + vice versa
disposable income = income left after after payment of personal income taxes
∴ increased personal income tax → decreased disposable tax → decreased consumer spending → leftward shift of AD curve + vice versa
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changes in personal income taxes
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indebtedness = how much money people owe from past loans
high level of indebtedness → pressure to pay back + interest → decreased present expenditure → leftward shift of AD curve + vice versa
high level of indebtedness → pressure to pay back + interest → decreased present expenditure → leftward shift of AD curve + vice versa
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changes in the level of household indebtedness
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changes in business confidence
changes in interest rates (monetary policy)
changes (improvements) in technology
changes in business taxes (fiscal policy)
level of corporate indebtedness
legal/institutional changes
changes in interest rates (monetary policy)
changes (improvements) in technology
changes in business taxes (fiscal policy)
level of corporate indebtedness
legal/institutional changes
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causes of changes in investment spending
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business confidence = measure of how optimistic firms are about future sales / economic activity
high business confidence → increased investment spending → rightward shift of AD curve + vice versa
high business confidence → increased investment spending → rightward shift of AD curve + vice versa
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changes in business confidence
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increased interest rates → increased cost of borrowing → reduction in investment spending financed by borrowing → leftward shift of AD curve + vice versa
*monetary policy
*monetary policy
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changes in interest rates (investment spending)
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improvements in technology stimulate investment spending → rightward shift of AD curve
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changes (improvements) in technology
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increased tax on business profits (fiscal policy) → fall in firms after-tax profits → decreased investment spending → leftward shift of AD curve + vice versa
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changes in business taxes (aggregate demand)
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high level of corporate indebtedness (past borrowing) → less investment spending → leftward shift of AD curve
*corporation = business legally separate from owners
*corporation = business legally separate from owners
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level of corporate indebtedness
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developing/transition economies have laws/institutions that limit small businesses accessing credit → small business cannot borrow easily to finance investments
∴ increased access to credit + securing property rights → increased investment spending → rightward shift of AD curve
∴ increased access to credit + securing property rights → increased investment spending → rightward shift of AD curve
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legal/institutional changes
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changes in political priorities
changes in economic priorities: deliberate efforts to influence aggregate demand (fiscal policy)
changes in economic priorities: deliberate efforts to influence aggregate demand (fiscal policy)
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causes of changes in government spending
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government expenditure = provision of merit/public goods, subsidies/pensions, wages salaries to government employees, etc.
government can increase/decrease expenditure in response to changes in priorities
increased government spending = rightward shift of AD curve + vice versa
government can increase/decrease expenditure in response to changes in priorities
increased government spending = rightward shift of AD curve + vice versa
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changes in political priorities
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government spending used to influence AD curve
*fiscal policy
*fiscal policy
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changes in economic priorities: deliberate efforts to influence aggregate demand
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changes in national income abroad
changes in exchange rates
changes in the level of trade protection
changes in exchange rates
changes in the level of trade protection
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causes of changes in export spending minus import spending
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country A has trade links with country B → increased national income in country B → country B imports more from country A → country A exports increase → rightward shift of country A aggregate demand
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changes in national income abroad
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exchange rate = price of one country's currency in terms of another country's currency
increase in price of country A currency relative to country B current
→ country A currency more expensive for country B → country B imports less from country A → fall in exports of country A → country A experiences leftward shift of AD curve + vice versa
→country B currency less expensive for country A → country A imports more from country B → increase in imports of country A → country A experiences leftward shift of AD curve + vice versa
increase in price of country A currency relative to country B current
→ country A currency more expensive for country B → country B imports less from country A → fall in exports of country A → country A experiences leftward shift of AD curve + vice versa
→country B currency less expensive for country A → country A imports more from country B → increase in imports of country A → country A experiences leftward shift of AD curve + vice versa
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changes in exchange rates
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trade protection = restrictions to free international trade often imposed by governments
country B imposes trade restrictions on imports of country A
→ country A exports fall → leftward shift of AD curve
→ country B imports fall → rightward shift of AD curve
country B imposes trade restrictions on imports of country A
→ country A exports fall → leftward shift of AD curve
→ country B imports fall → rightward shift of AD curve
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changes in the level of trade protection
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changes in national income cannot initiate any AD curve shifts
real GDP = horizontal axis = national income
∴ variable on axis cannot shift curve
real GDP = horizontal axis = national income
∴ variable on axis cannot shift curve
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reason for income not being a factor that can shift the aggregate demand (AD) curve
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wealth effect = movement along AD curve = change in real value of wealth that has resulted from a change in the price level
changes in wealth = shift of AD curve = changes in real wealth that have come about without any change in price level
*same applies for interest rate
changes in wealth = shift of AD curve = changes in real wealth that have come about without any change in price level
*same applies for interest rate
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distinction between wealth effect causing movements along the AD curve and changes in wealth that cause shifts of the AD curve
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period of time when prices of resources are roughly constant or inflexible (do not change in response to supply/demand) ∼ especially applicable to wages
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short run in macroeconomics
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period of time when the prices of all resources, including wages, are flexible and change along with changes in the price level
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long run in macroeconomics
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account for the largest part of firms costs of production ∴ strongly affect quantity of output supplied by firms
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explanation for wages being of special interest
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labour contracts fix wage rates for certain periods of time (=year/more)
minimum wage legislation fixes lowest legally permissible wage
workers / labour unions resist wage cuts
wage cuts have negative effects on worker morale causing workers to avoid them
minimum wage legislation fixes lowest legally permissible wage
workers / labour unions resist wage cuts
wage cuts have negative effects on worker morale causing workers to avoid them
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four reasons for the price of labour being rigid
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no effect
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affect of distinction between short and long run in aggregate demand
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total quantity of goods/services produced in an economy (real GDP) over a particular time period at different price levels
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aggregate supply
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shows relationship between price level and quantity of real output (real GDP) produced by firms when resource prices (especially wages) do not change
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short-run aggregate supply curve (SRAS)
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positive relationship between price level and real based on firm profitability
increased price level → increased output prices (short-run = unchanging resource prices) → increased firm profit → firms increase quantity of output produced + vice versa
increased price level → increased output prices (short-run = unchanging resource prices) → increased firm profit → firms increase quantity of output produced + vice versa
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the short-run aggregate supply curve (SRAS)
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increased short-run aggregate supply
firms produce larger quantity of real GDP for any price level
firms produce larger quantity of real GDP for any price level
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why the SRAS curve is upward-sloping
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decreased short-run aggregate supply
firms produce smaller quantity of real GDP for any price level
firms produce smaller quantity of real GDP for any price level
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rightward shift of SRAS curve
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changes in wages
changes in non-labour resource prices
changes in business taxes
changes in subsidies offered to businesses
supply shocks
changes in non-labour resource prices
changes in business taxes
changes in subsidies offered to businesses
supply shocks
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leftward shift of SRAS curve
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result of change in minimum wage legislation / labour union bargaining
increased wages (price level same) → increased firms cost of production → leftward shift of SRAS curve + vice versa
increased wages (price level same) → increased firms cost of production → leftward shift of SRAS curve + vice versa
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factors that cause shifts of the SRAS curve
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e.g. oil, equipment, capital goods, land inputs, etc.
increase price of factor of production → leftward shift of SRAS curve + vice versa
increase price of factor of production → leftward shift of SRAS curve + vice versa
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changes in wages
answer
business tax = tax on firm profit = cost of production
higher tax → increase cost of production → leftward shift of SRAS curve + vice versa
higher tax → increase cost of production → leftward shift of SRAS curve + vice versa
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changes in non-labour resource prices
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increase subsidy → rightward shift
decrease subsidy → leftward shift
decrease subsidy → leftward shift
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changes in business taxes (aggregate supply)
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supply shock = event with sudden and strong impact on short-run aggregate supply
destruction of output → leftward shift (+ vice versa) e.g. war / weather
/sudden change in price of cost of production e.g. oil
destruction of output → leftward shift (+ vice versa) e.g. war / weather
/sudden change in price of cost of production e.g. oil
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changes in subsidies offered to businesses
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point of intersection between AD and SRAS curves
determines price level / level of real GDP / level of unemployment
determines price level / level of real GDP / level of unemployment
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supply shocks
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real GDP increase → unemployment falls + vice versa
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short-run equilibrium level of output (or real GDP)
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recessionary (deflationary) gap
inflationary gap
full employment level of output
inflationary gap
full employment level of output
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relationship between real GDP and unemployment
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situation where real GDP is less than potential GDP (and unemployment is greater than the natural rate of unemployment) due to insufficient aggregate demand
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three short-run macroeconomic equilibrium positions
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situation where real GDP is greater than potential GDP (and unemployment is smaller than the natural rate of unemployment) due to excess aggregate demand
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three short-run equilibrium states of the economy
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full employment equilibrium level of GDP occurs when the AD and SRAS curves intersect at the level of potential GDP and there is no deflationary/inflationary gap
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recessionary (deflationary) gap
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points correspond to short-run macroeconomic equilibrium diagrams
deflationary (recessionary) gap = contraction/trough
inflationary gap = expansion/peak
full employment level of output = potential GDP
deflationary (recessionary) gap = contraction/trough
inflationary gap = expansion/peak
full employment level of output = potential GDP
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inflationary gap
answer
increase aggregate demand → rightward shift of AD curve → increase in price level → increase in real GDP → fall in unemployment + vice versa
increase aggregate supply → rightward shift of SRAS curve → lower price level → higher real GDP → lower unemployment + vice versa
increase aggregate supply → rightward shift of SRAS curve → lower price level → higher real GDP → lower unemployment + vice versa
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full employment level of output
answer
...
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relationship between three short-run equilibrium states of the economy and the business cycle
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fall in aggregate demand → recessionary gap
rise in aggregate demand → inflationary gap
fall in aggregate supply → economic contraction (increase price + decrease GDP) → stagflation (rising price level and decreasing GDP (rising unemployment)
*stagflation largely result of rising oil prices due to OPEC (Organisation of the Petroleum Exporting Countries) which cut back oil production
rise in aggregate supply → economic expansion → real GDP increase, price level fall
rise in aggregate demand → inflationary gap
fall in aggregate supply → economic contraction (increase price + decrease GDP) → stagflation (rising price level and decreasing GDP (rising unemployment)
*stagflation largely result of rising oil prices due to OPEC (Organisation of the Petroleum Exporting Countries) which cut back oil production
rise in aggregate supply → economic expansion → real GDP increase, price level fall
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impacts of changes in short-run macroeconomic equilibrium
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build on classical economists work of 19th century
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impacts of changes in short-run equilibrium
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importance of price mechanism in coordinating economic activities
concept of competitive market equilibrium
economy tends towards full employment
concept of competitive market equilibrium
economy tends towards full employment
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possible causes of the business cycle
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shape of aggregate supply curve
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shifts in AD or SRAS as possible causes of the business cycle
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AD curve and SRAS curve interest at any point on the LRAS curve
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monetarist/new classical economists
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LRAS curve is vertical at the full employment level of output (potential GDP) ∴ in the long-run the economy produces potential GDP which is independent of price level
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three key principles of monetarist/new classical model
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wages + resource prices change to match output price changes ∴ firms' costs of production remain constant even as price level changes
∴ increase/decrease price level + constant real costs → firms' profit constant → no incentive increase/decrease output levels
∴ increase/decrease price level + constant real costs → firms' profit constant → no incentive increase/decrease output levels
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key difference in different perspectives of the macroeconomy
answer
LRAS curve = vertical @ potential GDP ∴ recessionary/deflationary gaps cannot persist
a = long-run equilibrium → fall in aggregate demand AD₁ to AD₂ → b = recessionary gap = fall in real GDP + price level → long-run = fall in price level matched by fall in costs of production → rightward shift of SRAS from SRAS₁ to SRAS₂ back to LRAS curve @ c ∼ only fall is price level + vice versa
a = long-run equilibrium → fall in aggregate demand AD₁ to AD₂ → b = recessionary gap = fall in real GDP + price level → long-run = fall in price level matched by fall in costs of production → rightward shift of SRAS from SRAS₁ to SRAS₂ back to LRAS curve @ c ∼ only fall is price level + vice versa
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the LRAS curve and long-run equilibrium in the monetarist/new classical model
answer
eliminated ∼ ensures LRAS curve is vertical @ potential GDP
*economy has built in tendency towards full employment equilibrium
*economy has built in tendency towards full employment equilibrium
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long-run equilibrium in the monetarist/new classical model
answer
occurs when SRAS and AD intersect at different point on LRAS curve
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long-run aggregate supply curve according to the monetarist/new classical model
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AD can only influence real GDP in short-run
long-run ∼ AD can only influence price level ∴ increases in AD in long-run = inflationary
long-run ∼ AD can only influence price level ∴ increases in AD in long-run = inflationary
question
why the LRAS curve is vertical
answer
John Maynard Keynes ∼ famous 20th century economist ∼ basis of modern macroeconomics
question economic system = harmonious + tendency toward full employment ∼ short-run equilibrium can persist for long periods of time
question economic system = harmonious + tendency toward full employment ∼ short-run equilibrium can persist for long periods of time
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returning to long-run full employment equilibrium in the monetarist/new classical model
answer
...
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why inflationary and deflationary gaps cannot persist in the long run
answer
...
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recessionary (deflationary) and inflationary gaps in the long-run
answer
undefined
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changes in the long-run equilibrium
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undefined
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changes in long-run equilibrium in the monetarist/new classical AD-AS model
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undefined
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influence of aggregate demand in the long-run monetarist/new classical perspective
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undefined
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Keynesian economists
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undefined
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wages and price downward inflexibility
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undefined
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inability of economy to move into the long run
answer
undefined
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