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aggregate demand curve: describes the relationship between the quantity of aggregate output demanded and the price level when all other variables are held constant Quantity
Theory of Money Approach to Aggregate Demand V = (P x Y)/M equation of exchange: M x V = P x Y Quantity theory of money concludes that changes in aggregate spending are determined primarily by changes in the money supply. Deriving
the Aggregate Demand Curve See Figure 1 Shifts
in the Aggregate Demand Curve Deriving Aggregate Demand from the Behavior
of Its Components consumer expenditure: total demand for consumer goods and services planned investment spending: total planned spending by business firms on new machines, factories, and other inputs to production, plus planned spending on new homes government spending: spending by all levels of government (federal, state, and local) on goods and services net exports: net foreign spending on domestic goods and services, equal to exports minus imports Yad = C + I + G + NX Deriving
the Aggregate Demand Curve P ¯ ® i ¯ ® I ® Yad P ¯
®
i ¯ ® Factors
That Shift the Aggregate Demand Curve “animal spirits”: waves of optimism and pessimism on the part of consumers and businesses Summary See Table 1 |
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aggregate supply curve: the relationship between the quantity of output supplied and the price level Long-Run
Aggregate Supply Curve natural rate of unemployment: rate of unemployment to which the economy gravitates in the long run at which demand for labor equals supply natural level of output: level of aggregate output produced at the natural rate of unemployment See Figure 2 Short-Run
Aggregate Supply Curve See Figure 3 Shifts in the Short-Run Aggregate Supply Curve The short-run aggregate supply
curve shifts to the left when costs of production increase and to the right
when costs decrease. Factors that Shift the Short-Run Aggregate Supply
Curve Tightness
of the Labor Market When aggregate output is above the natural rate level, the aggregate supply curve shifts to the left; when aggregate output is below the natural rate level, the aggregate supply curve shifts to the right. Expected
Price Level A rise in the expected price level causes the aggregate supply curve to shift to the left; the greater the expected increase in the price level (that is, the higher the expected inflation), the larger the shift. Wage
Push A successful wage push by workers will cause the aggregate supply curve to shift to the left. Changes
in Production Costs Unrelated to Wages supply shocks: changes in technology and in the supply of raw materials A negative supply shock that raises production costs shifts the aggregate supply curve to the left; a positive supply shock that lowers production costs shifts the aggregate supply curve to the right. See Table 2 |
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Equilibrium
in the Short Run See Figure 4 Equilibrium in the Long Run See Figure 5 self-correcting mechanism: regardless of where output is initially, it returns eventually to the natural rate level activists: economists who are more likely to see the need for active government policy to restore the economy to full employment nonactivists: economists who see much less need for active government policy to restore the economy to the natural rate levels of output and unemployment Changes in Equilibrium Caused by Aggregate Demand
Shocks See Figure 6 Although the initial short-run effect of the rightward shift in the aggregate demand curve is a rise in both the price level and output, the ultimate long-run effect is only a rise in the price level. Changes in Equilibrium Caused by Aggregate Supply
Shocks See Figure 7 Although a leftward shift in the aggregate supply curve initially raises the price level and lowers output, the ultimate effect is that output and price level are unchanged (holding the aggregate demand curve constant.) Shifts in the Long-Run Aggregate Supply Curve:
Real Business Cycle Theory and Hysteresis real business cycle theory: theory of aggregate economic fluctuations in which aggregate supply (real) shocks do affect the natural rate of output hysteresis: a departure from full employment level as a result of past high unemployment |
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APPLICATION Explaining Past Business Cycles Episodes Vietnam War Buildup, 1964-1970 See Table 3 Negative Supply Shocks, 1973-1975 and
1978-1980 See Table 4 Favorable Supply Shocks, 1995-1999 See Table 5 Negative Demand Shocks, 2001-2004 See Table 6 |
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