The Macro Model

The Macro Model

National Income

Chapter 10

Apple CEO Steve Jobs

Graphing the Macro Model

The vertical axis of the measures the Price Level, rather than Price in the Micro Model

The horizontal axis of the measures Real GDP, rather than quantity of micro model

Price Level = PL Real GDP = RGDP

Long Run Aggregate Supply

The Long Run Aggregate Supply curve represents an economy where all inputs: land, labor and capital are used to their fullest efficiency

The Long Run Aggregate Supply Curve = LRAS

It is similar to the productions possibilities frontier on a production possibilities graph

Real GDP or National Income

The LRAS represents the economy running at “full employment” or the maximum level of national income.

The LRAS often uses Y to represent “full employment” RGDP or maximum National Income

Growth

The LRAS may shift to the right indicating that there has been economic growth of real GDP

This is similar to the shift out in the production possibilities graph

Increases in the LRAS

Growth created with the LRAS leads to increases in RGDP and decreases in price levels

This is a good situation for an economy when it can grow without price rises.

RGDP Contractions

The LRAS may also shrink with a real GDP contraction

This is indicated by the LRAS shifting to the left

This type of shift is called a supply shock

Decreases in the LRAS

Decreases in the LRAS can leads to decreases in Real GDP and increases in Price Levels

This type of inflation is called cost push inflation

What are the four components of Aggregate Demand?

C = Consumption I = Business Investment G = Government Spending NX= Net Exports = exports -

imports

Aggregate Demand

The macro model has a downward sloping aggregate demand curve

The Aggregate Demand = C+I+G+(NX)

Aggregate Demand is abbreviated AD

The place where the AD intersects the LRAS is the price level

Increases in Aggregate Demand

Increases in Aggregate demand lead to increases in price levels, however with the LRAS there is no change in RGDP

These increases are called demand pull inflation

This type of inflation is common during period of economic expansions

Decreases in Aggregate Demand

Decreases in Aggregate Demand lead to lower price levels, however real GDP does not change Real GDP

Decreases in aggregate demand commonly occurs during a contraction or recession

What happens to RGDP if price levels fall?

If price levels fall the RGDP will rise

What happens to RGDP if price levels rise?

If price levels rise the RGDP will fall

Why does the AD curve slope down?

Wealth Effect -(also called Real Balance Effect) if price level rises, people’s purchasing power goes down and if price levels fall people’s purchasing power goes up


Interest Rate Effect - if prices rise the real value of money goes down, therefore the demand to borrow money increases, driving up interest rates. Conversely if prices fall, interest rates fall.


Open Economy Effect - if price levels go up our net exports drop; if price levels goes down our net exports increase

What causes increases and decreases Aggregate Demand

Changes in price levels lead to changes in real GDP

There are a variety of non- price factors which can shift the Aggregate Demand curve up and down.

Look at the following examples, and figure out whether they will increase or decrease AD

People begin buying more food, clothing, and cars

Aggregate demand will rise

The federal government reduces military spending

Aggregate demand will fall

Sales tax is eliminated in California


Foreign countries buy more US exports


The money supply decreases

Aggregate demand will decrease

The US dollar becomes stronger compared to the Euro


The Federal Reserve Bank raises interest rates


A US company sells a jet to a foreign country

Aggregate Demand will rise

A US company buys coffee beans from Guatemala


A drop in the value of the dollar

Aggregate demand will increase

The Federal reserve restricts the money supply

Aggregate demand falls

Interest rates fall

Increase in aggregate demand

Europe and Japan suffers from a Depression

Aggregate Demand falls

China grows rapidly, and buys high tech US products

Aggregate Demand rises

Shifts in Long Run Aggregate Supply Curve

Which side are you on?

Consumer spending increases AD New inventions boost solar energy AS Government cuts back on military budget AD Government raises the retirement age on workers AS Business investment increases AD

Which side are you on?

Retraining of US workers make them more productive

AS New shale oil is discovered in the Rockies AS

Modern Macro Model with Short Run Aggregate Supply Curve

Short Run Aggregate Supply Curve

The short run aggregate supply curve or (SRAS) can shift when there are temporary efficiencies in capital, labor, and land

For example, plants can run at more than a 100% capacity, when they run at night.

Workers can work overtime, thus increasing the productivity of labor

Shifts in the short run Aggregate Supply

Short run increases in the supply curve is the result of:

Labor working overtime More efficient technologies are introduced The costs of labor, land or capital falls

Decreases in the SRAS

The SRAS can also decline if: Natural disasters disrupt the flow of

resources Any increase in the price of the inputs of

production: land, labor, and capital Any fall in the productivity or efficiency of

land,labor,and capital

What impact do each of these have on the SRAS?

New inventions make solar energy more efficiently produced

Increase in the SRAS


OPEC reduces their production of crude oil by 30%

decrease in the SRAS


Many people in the labor force take early retirements

decrease in the SRAS


Education and training for new workers increases sharply

Increase in the SRAS


Floods in the Midwest destroy 20% of the corn crop

Decrease in SRAS

Your turn

Make up four examples that will effect aggregate demand

Make up two more examples that will effect aggregate supply

Share your list with your neighbor

Documents

The Macro Model