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breif Mishkin PPT Ch22
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Copyright © 2010 Pearson Addison-Wesley. All rights reserved.
Chapter 22
Aggregate Demand and Supply Analysis
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Aggregate Demand
• The relationship between the quantity
of aggregate output demanded and the price level when all other variables are held constant.
• Aggregate demand is made up of four component parts
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The aggregate demand curve is downward sloping because
/and
/
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Y C I G NX
P M P i I Y
P M P i E NX Y
= + + +
↓⇒ ↑⇒ ↓⇒ ↑⇒ ↑
↓⇒ ↑⇒ ↓⇒ ↓⇒ ↑⇒ ↑
Aggregate Demand (cont’d)
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FIGURE 1 Shifts in the Aggregate Demand Curve
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Aggregate Demand (cont’d)
• The fact that the aggregate demand curve is downward sloping can also be derived from the quantity theory of money analysis.
• If velocity stays constant, a constant money supply implies constant nominal aggregate spending, and a decrease in the price level is matched with an increase in aggregate demand.
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Factors that Shift Aggregate Demand
• An increase in the money supply shifts AD to the right: holding velocity constant, an increase in the money supply increases the quantity of aggregate demand at each price level
• An increase in spending from any of the components C, I, G, NX, will also shift AD to the right
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Summary Table 1 Factors That Shift the Aggregate Demand Curve
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Aggregate Supply
• Long-run aggregate supply curve– Determined by amount of capital and labor and the available technology
– Vertical at the natural rate of output generated by the natural rate of unemployment
• Short-run aggregate supply curve– Wages and prices are sticky– Generates an upward sloping SRAS as firms attempt to take advantage of short-run profitability when price level rises
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FIGURE 2 Long-Run Aggregate Supply Curve
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FIGURE 3 Aggregate Supply Curve in the Short Run
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Factors that Shift SRAS
• Costs of production– Tightness of the labor market– Expected price level– Wage push– Change in production costs unrelated to wages (supply shocks)
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Summary Table 2 Factors That Shift the Short-Run Aggregate Supply Curve
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FIGURE 4 Equilibrium in the Short Run
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FIGURE 5 Adjustment to Long-Run Equilibrium in Aggregate Supply and Demand Analysis
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Self-Correcting Mechanism
• Regardless of where output is initially,
it returns eventually to the natural rate
• Slow– Wages are inflexible, particularly downward– Need for active government policy
• Rapid– Wages and prices are flexible– Less need for government intervention
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FIGURE 6 Response of Output and the Price Level to a Shift in the Aggregate Demand Curve
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FIGURE 7 Response of Output and the Price Level to a Shift in Short-Run Aggregate Supply
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Shifts in Long-Run Aggregate Supply• Economic growth• Real business cycle theory
– Real supply shocks drive short-run fluctuations in the natural rate of output (shifts of LRAS)
– No need for government intervention• Hysteresis
– Departure from full employment levels as a result of past high unemployment
– Natural rate of unemployment shifts upward and natural rate of output falls below full employment
– Expansionary policy needed to shift aggregate demand
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Conclusions
• Shift in aggregate demand affects output only in the short run and has no effect in the long run
• Shifts in aggregate demand affects only price level in the long run
• Shift in short run aggregate supply affects output and price only in the short run and has no effect in the long run (holding the aggregate demand constant)
• The economy has a self-correcting mechanism
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Table 3 Unemployment and Inflation During the Vietnam War Buildup, 1964–1970
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Table 4 Unemployment and Inflation During the Negative Supply Shocks Periods, 1973–1975 and 1978–1980
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Table 5 Unemployment and Inflation During the Favorable Supply Shocks Period, 1995–1999
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Table 6 Unemployment and Inflation During the Negative Demand Shocks Period, 2000–2004
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Table 7 Unemployment and Inflation During the Perfect Storm of 2007–2008