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PaulSchneiderman,Ph.D.

,ProfessorofFinance&Economics,Southern
NewHampshireUniversity
2008SouthWestern

InThisLecture..
AggregateDemand
FactorsThatCanChangeAD
ShortRunAggregateSupply
ShortRunEquilibrium
LongRunAggregateSupplyandLongRun
Equilibrium
ThreeStatesofanEconomy

AggregateDemand
AggregateDemand
Thequantitydemandedofallgoodsand
services(RealGDP)atdifferentprice
levels,ceterisparibus.
AggregateDemand(AD)Curve
Acurvethatshowsthequantity
demandedofallgoodsandservices(Real
GDP)atdifferentpricelevels,ceteris
paribus.

TheAggregateDemandCurve
Theaggregated
demandcurveis
downwardsloping,
specifyingan
inverserelationship
betweentheprice
level andthe
quantitydemanded
ofRealGDP.

WhyDoestheAggregateDemand
CurveSlopeDownward?
RealBalanceEffect
InterestRateEffect
InternationalTrade
Effect

RealBalanceEffect
Thechangein
the
purchasing
powerof
dollar
denominated
assetsthat
resultsfroma
changeinthe
pricelevel

InterestRateEffect
Changesin
household
andbusiness
buyingasthe
interestrate
changes

InternationalTradeEffect
Thechangein
foreignsector
spendingas
thepricelevel
changes

ChangeinQuantity
Demanded
Achangeinthequantity
demandedofRealGDPis
graphicallyrepresentedas
amovementfromone
point,A,onAD1to
anotherpoint,B,onAD1.
Achangeinthequantity
demandedofRealGDPis
theresultofachangein
thepricelevel.

ChangeinAggregateDemand
Achangein
aggregatedemandis
graphically
representedasashift
intheaggregate
demandcurvefrom
AD1toAD2

ChangeinAggregateDemand

FactorsThatChangeAggregate
Demand&Consumption/Wealth
Wealth Thevalueofallassetsowned,both
monetaryandnon monetary

Wealth C AD
Wealth C AD

FactorsThatChangeAggregate
Demand&Consumption/Prices
Expecthigherfutureprices C AD
Expectlowerfutureprices C AD

FactorsThatChangeAggregate
Demand&Consumption/Income
Expecthigherfutureincome C D
Expectlowerfutureincome C AD

FactorsThatChangeAggregate
Demand&Consumption/Interest
Rates
InterestRate C AD
InterestRate C AD

FactorsThatChangeAggregate
Demand&Consumption/Income
Taxes
Incometaxes C AD
Incometaxes C AD

FactorsThatChangeAggregate
Demand&Investment/InterestRates
Interestrates I AD
Interestrates I AD

FactorsThatChangeAggregate
Demand&Investment/FutureSales
Optimisticaboutfuturesales I AD
Pessimisticaboutfuturesales I AD

FactorsThatChangeAggregate
Demand&Investment/BusinessTaxes
Businesstaxes I AD
Businesstaxes I AD

FactorsThatChangeAggregateDemand&
NetExports/ForeignRealNationalIncome
Foreignrealnationalincome EX NX AD
Foreignrealnationalincome EX NX AD

FactorsThatChangeAggregateDemand&
NetExports/ExchangeRate
Takadepreciates EX andIM NX AD
Takaappreciates EX andIM NX AD

Appreciation
Anincreaseinthevalueof
onecurrencyrelativeto
othercurrencies.

Depreciation
Adecreaseinthevalueof
onecurrencyrelativeto
othercurrencies.

FactorsThatChangeAggregate
Demand

SelfTestQuestions
Explaintherealbalanceeffect.
ExplainwhathappenstotheADcurveif
thedollarappreciatesrelativetoother
currencies.
ExplainwhathappenstotheADcurveif
personalincometaxesdecline.

ShortRunAggregateSupply
AggregateSupply
Thequantitysuppliedofallgoodsand
services(RealGDP)atdifferentprice
levels,ceterisparibus.
ShortRunAggregateSupply(SRAS)Curve
Acurvethatshowsthequantitysupplied
ofallgoodsandservicesRealGDP)at
differentpricelevels,ceterisparibus.

ShortRunAggregateSupply
Curve
Theshortrun
aggregatesupply
curve(SRAS)is
upward sloping,
specifyingadirect
relationshipbetween
thepriceleveland
thequantitysupplied
ofRealGDP.

WhyDoestheAggregateSupply
CurveSlopeUpward?
Twopossibleexplanations:
Stickywages
Workermisconceptions

StickyWages,theRealWage
Rate,andSRAS
Wagesarelockedin forafewyearsdue
tolaborcontractsorperhapsbecauseof
socialconventionsorperceivednotionsof
fairness.
Whilefirmspaynominalwages,they
oftendecidehowmanyworkerstohire
basedonrealwages.

StickyWagesandtheRealWage
Rate Workers
TheRealwage=Nominalwage/Pricelevel.
PricelevelReal wage , ceteris paribus
PricelevelReal wage , ceteris paribus
Moreindividualsarewillingtowork,and
currentworkersarewillingtoworkmoreat
higherrealwagesthanatlowerrealwagesand
viceversa.
Realwage Quantity supplied of labor
Realwage Quantity of labor supplied

StickyWagesandtheRealWage
Rate Firms
Firms will employ more workers the cheaper it is
to hire them.
Realwage Quantity of labor demanded
Realwage Quantity of labor demanded
Thus,ifwagesaresticky,anincreaseintheprice
level(whichpushesrealwagesdown)willresultin
aincreaseinoutput.Thisiswhatanupward
slopingSRAScurverepresents:Asthepricelevel
rises,thequantitysuppliedofgoodsandservices
rises.Theoppositeoccursifpricelevelsfall.

WorkerMisconceptions
Ifworkersmisperceiverealwagechanges,then
afallinthepricelevelwillbringaboutadecline
inoutput,ceterisparibus,whichisillustrativeof
anupwardslopingSRAScurve.
Inresponseto(themisperceived)fallingreal
wage,workersmayreducethequantityoflabor
theyarewillingtosupply.Withfewerworkers
(resources),firmswillendupproducingless.

ChangesinSRAS

ChangesinSRAS
ShiftsintheSRAScurvemaybecausedby
changesin:
Wagerates
Pricesofnonlaborinputs
Productivity
Supplyshocks
Adverse
Beneficial

ChangesinSRAS

SelfTestQuestions
Ifwageratesdecline,explainwhat
happenstotheshortrunaggregatesupply
(SRAS)curve.
Giveanexampleofanincreaseinlabor
productivity.
Discussthedetailsoftheworker
misperceptionsexplanationforthe
upwardslopingSRAScurve.

ShortrunEquilibrium
AtP1,thequantitysupplied
ofRealGDPisgreaterthanthe
quantitydemanded.Asaresult,
thepricelevelfallsandfirms
decreaseoutput.
AtP2,thequantitydemanded
ofRealGDPisgreaterthanthe
quantitysupplied.Asaresult,
thepricelevelrisesandfirms
increaseoutput.
Shortrunequilibriumoccurs
atpointE,wherethequantity
demandedofRealGDPequals
the(shortrun)quantity
supplied.

ChangesinShortRunEquilibrium
intheEconomy

ADandSRAS

NaturalRealGDP&Natural
Unemployment
TheRealGDPthatisproducedatthe
naturalunemployment*rate.TheReal
GDPthatisproducedwhentheeconomy
isinlongrunequilibrium.
*Unemploymentcausedbyfrictionalandstructural
factorsintheeconomy.

LongRunAggregateSupply
(LRAS)Curve
TheLRAScurveisa
verticallineatthelevel
ofNaturalRealGDP.It
representstheoutput
theeconomyproduces
whenalleconomywide
adjustmentshavetaken
placeandworkersdo
nothaveanyrelevant
misperceptions.

EquilibriumStatesofthe
Economy

Duringthetimeaneconomymovesfromone
equilibriumtoanother,itissaidtobeindisequilibrium.

ShortRunEquilibrium
Theconditionthatexistsintheeconomy
whenthequantitydemandedofRealGDP
equalsthe(shortrun)quantitysuppliedof
RealGDP.Thisconditionismetwherethe
aggregatedemandcurveintersectsthe
shortrunaggregatesupplycurve.

LongrunEquilibrium
Theconditionthatexistsintheeconomy
whenwagesandpriceshaveadjustedto
their(final)equilibriumlevelsand
workersdonothaveanyrelevant
misperceptions.Graphically,longrun
equilibriumoccursattheintersectionof
theADandLRAScurves.

SelfTestQuestions
Whatisthedifferencebetweenshortrun
equilibriumandlongrunequilibrium?
Diagrammaticallyrepresentaneconomy
thatisinneithershortrunequilibriumnor
longrunequilibrium.

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