Chapter-33-Aggregate-demand-and-aggregate-supply

CHAPTERChapter33AggregateDemandandAggregateSupplyMacro-economicsPRINCIPLESOFN.GregoryMankiwInthischapter,lookfortheanswerstothesequestions:Whatareeconomicfluctuations?Whataretheircharacteristics?Howdoesthemodelofaggregatedemandandaggregatesupplyexplaineconomicfluctuations?WhydoestheAggregate-Demandcurveslopedownward?WhatshiftstheADcurve?WhatistheslopeoftheAggregate-Supplycurveintheshortrun?Inthelongrun?WhatshiftstheAScurve(s)?1AGGREGATEDEMANDANDAGGREGATESUPPLY2IntroductionOverthelongrun,realGDPgrowsabout3%peryearonaverage.Intheshortrun,GDPfluctuatesarounditstrend.Recessions:periodsoffallingrealincomesandrisingunemploymentDepressions:severerecessions(veryrare)Short-runeconomicfluctuationsareoftencalledbusinesscycles.02,0004,0006,0008,00010,00012,00014,0001965197019751980198519901995200020052010ThreeFactsAboutEconomicFluctuations3TheshadedbarsarerecessionsU.S.realGDP,billionsof2000dollarsFACT1:Economicfluctuationsareirregularandunpredictable.05001,0001,5002,0002,5001965197019751980198519901995200020052010ThreeFactsAboutEconomicFluctuations4FACT2:Mostmacroeconomicquantitiesfluctuatetogether.Investmentspending,billionsof2000dollars0246810121965197019751980198519901995200020052010ThreeFactsAboutEconomicFluctuations5FACT3:Asoutputfalls,unemploymentrises.Unemploymentrate,percentoflaborforceAGGREGATEDEMANDANDAGGREGATESUPPLY6Introduction,continuedExplainingthesefluctuationsisdifficult,andthetheoryofeconomicfluctuationsiscontroversial.Mosteconomistsusethemodelofaggregatedemandandaggregatesupplytostudyfluctuations.Thismodeldiffersfromtheclassicaleconomictheorieseconomistsusetoexplainthelongrun.AGGREGATEDEMANDANDAGGREGATESUPPLY7ClassicalEconomics—ARecapThepreviouschaptersarebasedontheideasofclassicaleconomics,especially:TheClassicalDichotomy,theseparationofvariablesintotwogroups:Real–quantities,relativepricesNominal–measuredintermsofmoneyTheneutralityofmoney:Changesinthemoneysupplyaffectnominalbutnotrealvariables.AGGREGATEDEMANDANDAGGREGATESUPPLY8ClassicalEconomics—ARecapMosteconomistsbelieveclassicaltheorydescribestheworldinthelongrun,butnottheshortrun.Intheshortrun,changesinnominalvariables(likethemoneysupplyorP)canaffectrealvariables(likeYortheu-rate).Tostudytheshortrun,weuseanewmodel.AGGREGATEDEMANDANDAGGREGATESUPPLY9TheModelofAggregateDemandandAggregateSupplyPYADSRASP1Y1ThepricelevelRealGDP,thequantityofoutputThemodeldeterminestheeq’mpricelevelandeq’moutput(realGDP).“AggregateDemand”“Short-RunAggregateSupply”AGGREGATEDEMANDANDAGGREGATESUPPLY10TheAggregate-Demand(AD)CurveTheADcurveshowsthequantityofallg&sdemandedintheeconomyatanygivenpricelevel.PYADP1Y1P2Y2AGGREGATEDEMANDANDAGGREGATESUPPLY11WhytheADCurveSlopesDownwardY=C+I+G+NXAssumeGfixedbygovtpolicy.TounderstandtheslopeofAD,mustdeterminehowachangeinPaffectsC,I,andNX.PYADP1Y1P2Y2Y1AGGREGATEDEMANDANDAGGREGATESUPPLY12TheWealthEffect(PandC)SupposePrises.Thedollarspeopleholdbuyfewerg&s,sorealwealthislower.Peoplefeelpoorer.Result:Cfalls.AGGREGATEDEMANDANDAGGREGATESUPPLY13TheInterest-RateEffect(PandI)SupposePrises.Buyingg&srequiresmoredollars.Togetthesedollars,peoplesellbondsorotherassets.Thisdrivesupinterestrates.Result:Ifalls.(Recall,Idependsnegativelyoninterestrates.)AGGREGATEDEMANDANDAGGREGATESUPPLY14TheExchange-RateEffect(PandNX)SupposePrises.U.S.interestratesrise(theinterest-rateeffect).ForeigninvestorsdesiremoreU.S.bonds.Higherdemandfor$inforeignexchangemarket.U.S.exchangerateappreciates.U.S.exportsmoreexpensivetopeopleabroad,importscheapertoU.S.residents.Result:NXfalls.AGGREGATEDEMANDANDAGGREGATESUPPLY15TheSlopeoftheADCurve:SummaryAnincreaseinPreducesthequantityofg&sdemandedbecause:PYADP1Y1thewealtheffect(Cfalls)P2Y2theinterest-rateeffect(Ifalls)theexchange-rateeffect(NXfalls)AGGREGATEDEMANDANDAGGREGATESUPPLY16WhytheADCurveMightShiftAnyeventthatchangesC,I,G,orNX–exceptachangeinP–willshifttheADcurve.Example:Astockmarketboommakeshouseholdsfeelwealthier,Crises,theADcurveshiftsright.PYAD1AD2Y2P1Y1AGGREGATEDEMANDANDAGGREGATESUPPLY17WhytheADCurveMightShiftChangesinCStockmarketboom/crashPreferencesre:consumption/savingtradeoffTaxhikes/cutsChangesinIFirmsbuynewcomputers,equipment,factoriesExpectations,optimism/pessimismInterestrates,monetarypolicyInvestmentTaxCreditorothertaxincentivesAGGREGATEDEMANDANDAGGREGATESUPPLY18WhytheADCurveMightShiftChangesinGFederalspending,e.g.,defenseState&localspending,e.g.,roads,schoolsChangesinNXBooms/recessionsincountriesthatbuyourexports.Appreciation/depreciationresultingfrominternationalspeculationinforeignexchangemarketWhathappenstotheADcurveineachofthefollowingscenarios?A.Aten-year-oldinvestmenttaxcreditexpires.B.TheU.S.exchangeratefalls.C.Afallinpricesincreasestherealvalueofconsumers’wealth.D.Stategovernmentsreplacetheirsalestaxeswithnewtaxesoninterest,dividends,andcapitalgains.ACTIVELEARNING1TheAggregate-Demandcurve19A.Aten-year-oldinvestmenttaxcreditexpires.Ifalls,ADcurveshiftsleft.B.TheU.S.exchangeratefalls.NXrises,ADcurveshiftsright.C.Afallinpricesincreasestherealvalueofconsumers’w