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AE Model
Is this is a good model?
Why?
What are the pros and cons?
AGGREGATE DEMAND
Remember AD is very different from
demand in micro economics!
The two demand curves look similar but
are two completely different models so be
careful not to confuse them!
Demand curves in micro represent
demand for an individual good or service
AGGREGATE DEMAND
Note a change in the price level results in a movement
along the AD curve
A change in any one of the elements of AE (C, I, G, net
exports) will bring about a shift of the entire aggregate
demand curve.
Are you really concentrating on this topic and taking
detailed notes?
AGGREGATE DEMAND
SHIFTS IN THE AD CURVE
If the price level changes we move along the AD
curve (movement). On the other hand the whole AD
curve could shift. This could be caused by:
A change in interest rates
Changes in tax levels by government
Expectations and confidence levels
1.What will a shift outwards mean?
2.What could cause the AD curve to shift left?
3.Draw and explain with an example what could
cause AD to shift left and right (see fig 10.2 p204)
Hello Friday!
Today
we
are
going
to
learn
about
aggregate
supply
Two
schools
of
thought:
Neo
classical
Keynesian
(handout)
Which
one
do
you
think
we
use
most
frequently?
AGGREGATE SUPPLY
The AS curve shows the level of real
domestic output that will be produced at each
price level. The AS curve is upward sloping.
= relationship between total production of
goods and services and general price level
There are two types of AS curves what are
they?
Why does one AS slope upwards?
Why are you talking when you need to be
listening?
AGGREGATE SUPPLY
Short run AS curve (SRAS)
- Shows the impact of an increase in total
production (GDP) on the inflation rate
- Positive slope
- As level of economic activity increases,
price level increases
- Rising production requires increases in
labour and capital: most important is cost of
labour (wages)
- As economic activity increases wages rise
causing general price level to rise as well
- Figure 10.3 (page 205)
AGGREGATE SUPPLY
Long run AS curve (LRAS)
- Shows the economys potential level of real GDP when ALL
resources are fully employed
- Shows economys full employment level of output (the
natural rate of unemployment = 5% in Australian economy)
- Vertical: representing maximum level of output at a
particular point in time: level of real GDP DOES NOT
change as price changes
- To shift economy needs to grow and resources increase:
output increases through improvements in technology,
capital stock increases, labour force increases (roughly
3.5% per year)
- Figure 10.3 (page 205)
- Come on hurry up35 hours and counting..
Welcome to Week 2 J
MACROECONOMIC EQUILIBRIUM
The intersection of the 3 curves, AD,
SRAS and LRAS describes
macroeconomic equilibrium.
1.Draw this situation.
2.Describe what is happening in the
economy at this point.
MACROECONOMIC EQUILIBRIUM
Economy said to be in short run equilibrium
when AD intersects with SRAS
Represents economys ACTUAL level of
production
Economy said to be in long run equilibrium
when all THREE curves intersect
At this point ACTUAL GDP = POTENTIAL
GDP, short run equilibrium coincides with
long run equilibrium
At this point economy is at its natural rate of
unemployment with a low rate of inflation
(page 208 figure 10.5)
Multiplier Essay
MACROECONOMIC EQUILIBRIUM
Does an economy ALWAYS operate at a
long run equilibrium?
Why?
MACROECONOMIC EQUILIBRIUM
In the case of Australia this would mean:
- Unemployment would be 5%
- Inflation would be 2.5%
- GDP growth would be 3.5%
What is the reality? What are the actual
figures for these measures? What does
it mean?
MACROECONOMIC EQUILIBRIUM
What actually happens in real life?
- Every year 3 curves shift to the right (economic
growth, population increase, labour force
increases, technology improves, capital stock
grows and new resources are found)
- Income increases and therefore AD increases
through increased consumption
- Investment increases as does government
spending
The result? AD and AS may not shift in same
proportion so SRAS is either above or below LRAS
CONTRACTIONARY GAP
vEquilibrium level of of real GDP is less
than potential GDP
vHigher levels of cyclical unemployment
(above natural rate)
vInflation low: extra capacity in the
economy
CONTRACTIONARY GAP
vCharacteristics:
vDemand for final goods and services falls =
higher unemployment
vFall in labour force participation rates: people
dont think they will find a job
vFall in profits = fall in business confidence
vReduction in sales of durables and slower rate
growth of consumer expenditure
vFalling share prices = reduced investment
vIncreased government spending on welfare
(unemployment)
vLower IR
vFewer imports and improved CAD
CONTRACTIONARY GAP
vWhat happens?
vSelf correcting mechanism to push
economy into long run equilibrium: wages
fall (as over supply of labour) shifts SRAS
downwards, moving economy back to
potential GDP. AD likely to increase due to
improved HH and business confidence
OR
vGovernment intervention to shift AD to right
(fiscal and monetary policies)
EXPANSIONARY GAP
vAD intersects SRAS to right of LRAS
vEquilibrium level of real GDP is greater
than potential GDP
vUnemployment less than natural rate
vInflation high (competition for limited
resources)
EXPANSIONARY GAP
vCharacteristics:
vLow levels cyclical unemployment : consumer
demand high so firms need to employ labour to
produce goods to meet demand
vRise in labour force participation rates
vRising inflationary pressures (increased
competition)
vIncrease in profits = increased confidence
vIncrease in consumer confidence = increase in
demand for durables
vRising share prices
vReduction in government spending
vHigher IR
vIncreased imports = increase in CAD
EXPANSIONARY GAP
vWhat happens?
vEconomy has self correcting measures:
actual GDP is greater than potential GDP,
wages rise as unemployment less than
natural rate = shifts SRAS to left moves
economy back towards potential GDP.
Prices rise = reduced confidence and AD
decreases
OR
vGovernment intervenes to reduce consumer
spending to shift AD to left (e.g. higher
taxes)