Ch 26 - Aggregate demand and supply

Friday, March 09, 2012

1:20 AM

    Important Aggregate supply


    Quantity of real GDP supplied

    Total quantity that firms plan to produce during a given period

    Aggregate supply (AS)

    Relationship between Q of GDP supplied and price level

    Long-run AS

    Wages, prices of other goods, potential GDP can vary

    Short-run AS

    Wages, prices of other goods, potential GDP is fixed



    Price rises: (direct)

    wages is constant
    profits increase
    firms produce more
    increase in GDP


    Prices rises: (vertical)

    profits rise initially
    firms produce more
    wage match price increase (cost increase)
    production decreases

    LRAS = Potential GDP
    (pure inflation when LRAS stays constant)

    Real GDP = Potential GDP
    (due to wage fluctuations)


    Important AS determinants

    Potential GDP

    When increase:
    LRAS and SRAS shift right

    Change due to:

    • full-employment adjustment
    • Quantity of capital
    • Technology

    Wage rate

    (factor price)

    SRAS moves inversely. No affect on LAS.



    Important Aggregate Demand



    Relationship between the quantity of real GDP demanded and the price level

    Wealth effect

    Prices increase -> wealth falls -> GDP decreases

    Intertemporal substitution effect

    Interest rate increase -> less spending

    International substitution effect

    Increase in price -> increase import, decrease export


    AD dependencies

    Price level

    Movement along the curve


    About future income, inflation, profits (direct)

    Fiscal policy

    Government's taxes (inverse), and transfer payments (direct), government expenditure (direct)

    Monetary policy

    Interest rates (inverse) and quantity of money (direct)

    World economy

    Foreign exchange rate (direct)


    Short-run macro equilibrium

    Quantity of real GDP demanded = Quantity of real GDP supplied (SRAS)

    Long-run macro equilibrium

    AD = SRAS = LRAS


    Below full-employment eq

    Real GDP < potential GDP

    Recessionary gap

    Money wage rises -> decrease in SRAS

    Above full-employment eq

    Real GDP > potential GDP

    Inflationary gap

    Money wage falls -> increase in SRAS

    Full-employment eq

    Real GDP = potential GDP





    It is smaller when price fluctuates (increase in GDP increases price level)



    SRAS decreases, price level rises


    Classical View



    Money wage is "sticky", hard to decrease
    Need government to offset using taxes


    Money wage is "sticky", hard to decrease
    Need money growth.


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