Model of aggregate demand and aggregate supply. Topic 3 презентация

1. Aggregate demand and its model. AD curve
AGGREGATE DEMAND (AD) – is a schedule or curve that shows the amounts of real output (real GDP) that buyers collectively desire to purchase at each possible price level.
The relationship between the price level (as measured by the GDP price index) and the amount of real GDP demanded is inverse or negative: When the price level rises, the quantity of real GDP demanded decreases; when the price level falls, the quantity of real GDP demanded increases.

1. Aggregate demand and its model. AD curve
Aggregate demand is the planned expenditure in all sectors of the economy. It contains four components:
1) expenditures of the private sector of the country for consumption (C) and investment (I);
2) expenditures of the state for the purchase of goods, payment for services and labor (G);
3) net exports of the country (NE) = export – import
AD = C+I+G+NE

1. Aggregate demand and its model. AD curve
Because of the negative relationship between the level of prices and the volume of the national product the aggregate demand curve has a negative inclination.

1. Aggregate demand and its model. AD curve
AD factors are divided into:
Price related – factors that show how price of the product influence AD
Non-price related – show how other price factors except of price of the product influence AD

1. Aggregate demand and its model. AD curve
Price related factors:
1. Real-Balances Effect (wealth effect)- with the growth of prices, decreases the purchasing power of financial assets (cash); buyers reduce their expenditure and aggregate demand is decreasing and the opposite.

1. Aggregate demand and its model. AD curve
Price related factors:
2. Interest-Rate(Savings) Effect - with the increase of the general level of prices, the demand for money for the purchase of more expensive goods and services increases, which leads to an increase in the interest rate and a decrease in investments, which in turn limits the aggregate demand.
p↑→ Мd ↑ → і↑→ І↓→АD↓
And vice versa:
p↓→ Мd ↓→ і↓→ І↑→ АD↑

1. Aggregate demand and its model. AD curve
3. Foreign Purchases Effect - the increase in the general level of domestic prices in comparison with the prices abroad leads to inflation, and, consequently, the decrease in exports, and the growth of imports, which will lead to a decrease in net exports and a decrease in aggregate demand.

NON PRICE RELATED FACTORS shift the aggregate demand curve.
They are also known as Aggregate demand shifters:

1. Aggregate demand and its model. AD curve
1. Change in consumer spending
Consumer Wealth - is the total dollar value of all assets owned by consumers in the economy less the dollar value of their liabilities (debts). Assets include stocks, bonds, and real estate. Liabilities include mortgages, car loans, and credit card balances.
Household Borrowing. Consumers can increase their consumption spending by borrowing. Doing so shifts the aggregate demand curve to the right. By contrast, a decrease in borrowing for consumption purposes shifts the aggregate demand curve to the left.

1. Aggregate demand and its model. AD curve
1. Change in consumer spending
Consumer Expectations .When people expect their future real incomes to rise, they tend to spend more of their current incomes. Thus, current consumption spending increases and the aggregate demand curve shifts to the right.
Personal Taxes. Tax cuts shift the aggregate demand curve to the right. Tax increases reduce consumption spending and shift the curve to the left.

1. Aggregate demand and its model. AD curve
2. Investment Spending
Real Interest Rates Other things equal, an increase in real interest rates will lower investment spending and reduce aggregate demand.
Expected Returns Higher expected returns on investment projects will increase the demand for capital goods and shift the aggregate demand curve to the right.
Alternatively, declines in expected returns will decrease investment and shift the curve to the left.

1. Aggregate demand and its model. AD curve
Expected returns, in turn, are influenced by several factors:
Expectations about future business conditions If firms are optimistic about future business conditions, they are more likely to forecast high rates of return on current investment and therefore may invest more today.
Technology New and improved technologies enhance expected returns on investment and thus increase aggregate demand.
Degree of excess capacity A rise in excess capacity— unused capital—will reduce the expected return on new investment and hence decrease aggregate demand. Other things equal, firms operating factories at well below capacity have little incentive to build new factories.
Business taxes An increase in business taxes will reduce after-tax profits from capital investment and lower expected returns.

1. Aggregate demand and its model. AD curve
3. Government Spending
An increase in government purchases (for example, more military equipment) will shift the aggregate demand curve to the right, as long as tax collections and interest rates do not change as a result. In contrast, a reduction in government spending (for example, fewer transportation projects) will shift the curve to the left.

1. Aggregate demand and its model. AD curve
4. Net Export Spending
Other things equal, higher U.S. exports mean an increased foreign demand for U.S. goods.
So a rise in net exports shifts the aggregate demand curve to the right. In contrast, a decrease in U.S. net exports shifts the aggregate demand curve leftward.

1. Aggregate demand and its model. AD curve
Causes of net exports change:
National Income Abroad Rising national income abroad encourages foreigners to buy more products, some of which are made in the United States. U.S. net exports thus rise, and the U.S. aggregate demand curve shifts to the right.
Exchange Rates Changes in the dollar’s exchange rate—the price of foreign currencies—may affect exports and therefore aggregate demand.
Dollar depreciation increases net exports (imports go down; exports go up) and therefore increases aggregate demand.
Dollar appreciation has the opposite effects: Net exports fall (imports go up; exports go down) and aggregate demand declines.

2. Aggregate supply in the short and long run. Factors affecting the aggregate supply. AS curve.
AGGREGATE SUPPLY (AS) – is a schedule or curve showing the relationship between the price level and the amount of real domestic output that firms in the economy produce.
The national economy can respond to changes in aggregate demand either by increasing the volume of the real product or by changing the price level.

2. Aggregate supply in the short and long run. Factors affecting the aggregate supply. AS curve.
FULL EMPLOYMENT OUTPUT LEVEL (Potential GDP) is the production level when all available resources are used efficiently. It equals the highest level of production an economy can sustain for the long-run.
It is also referred to as the full employment production, natural level of output or long-run aggregate supply.

АS Shifters or non-price related factors of AS.

2. Aggregate supply in the short and long run. Factors affecting the aggregate supply. AS curve.
1. Input Prices
Input or resource prices—to be distinguished from the output prices that make up the price level—are a major ingredient of per-unit production costs and therefore a key determinant of aggregate supply. These resources can either be domestic or imported.
Domestic Resource Prices Wages and salaries make up about 75 percent of all business costs. Other things equal, decreases in wages reduce per-unit production costs. So the aggregate supply curve shifts to the right. Increases in wages shift the curve to the left.

2. Aggregate supply in the short and long run. Factors affecting the aggregate supply. AS curve.
Prices of Imported Resources
Just as foreign demand for national goods contributes to our aggregate demand, resources imported from abroad (add to national aggregate supply.
Added suppliesof resources—whether domestic or imported—typically reduce per-unit production costs. A decrease in the price of imported resources increases national aggregate supply, while an increase in their price reduces national aggregate supply.

2. Aggregate supply in the short and long run. Factors affecting the aggregate supply. AS curve.
2. Change in productivity
Productivity- is a measure of the relationship between a nation’s level of real output and the amount of resources used to produce that output.
An increase in productivity enables the economy to obtain more real output from its limited resources. It does this by reducing the per-unit cost of output (per-unit production cost).

2. Aggregate supply in the short and long run. Factors affecting the aggregate supply. AS curve.
3. Change in legal-institutional environment
Business Taxes and Subsidies Higher business taxes, such as sales, and payroll taxes, increase perunit costs and reduce short-run aggregate supply in much the same way as a wage increase does.
Similarly, a business subsidy—a payment or tax break by government to producers—lowers production costs and increases short-run aggregate supply.
Government Regulation It is usually costly for businesses to comply with government regulations. More regulation therefore tends to increase per-unit production costs and shift the aggregate supply curve to the left.

The shape of the AS curve is interpreted differently in Classical and Keynesian theories.
Classical theory describes the economy in the long run. The analysis of the aggregate supply in the classical theory is based on the following conditions:
markets are competitive;
the volume of output depends only on the number of factors of production (labor and capital) and technology and does not depend on the price level;
changes in factors of production and technology are slow;
the economy operates at full employment output level;
prices and nominal wages - are flexible, their changes maintain the balance in the markets.
The AS curve in the long run (LRAS) has vertical form at full employment output level.
Any fluctuations in aggregate demand are reflected at the price level.

2. Aggregate supply in the short and long run. Factors affecting the aggregate supply. AS curve.

2. Aggregate supply in the short and long run. Factors affecting the aggregate supply. AS curve.
Keynesian theory considers the functioning of the economy in the short run. The analysis of aggregate supply in the Keynesian theory is based on the following conditions:
the economy operates under conditions of partial employment of factors of production;
prices, nominal wages and other nominal values ​​are relatively rigid, slowly react to market fluctuations;
real values ​​(output, employment, real wages, etc.) are more mobile, react more quickly to market fluctuations.
The short-term aggregate curve has two segments - the extreme Keynesian and ascending

2. Aggregate supply in the short and long run. Factors affecting the aggregate supply. AS curve.
The extreme Keynesian segment reflects the situation when the economy is in decline, and therefore a significant proportion of production capacity and labor is not used. In this segment, actual production is smaller than full employment output level. The volume of the national product is small, and therefore its increase does not lead to the increase in prices level.

2. Aggregate supply in the short and long run. Factors affecting the aggregate supply. AS curve.
The intermediate or ascending segment of the aggregate supply curve is characterized by the fact that the expansion of production is accompanied by an increase in the price level.
With the expansion of production and the approach to full utilization of their capacities, individual enterprises are forced to use less efficient equipment and insufficiently skilled workers. Thus, the costs per unit of production are increasing. In order for production to remain profitable, firms set higher prices for products.
At this segment of the AS curve, an increase in the real volume of the product is leading to an increase in level of prices.

2. Aggregate supply in the short and long run. Factors affecting the aggregate supply. AS curve.
The vertical (classical) segment shows changes in GDP when it reaches maximum, under full employment conditions (the level of actual unemployment is equal to natural unemployment), and there is no additional growth in real GDP, and therefore an inflationary rise in prices occurs.

3. Macroeconomic equilibrium in AD-AS model.
At the point of intersection of the curves of aggregate demand and aggregate supply equilibrium level of prices and the equilibrium volume of production of the national product are achieved.

3. Macroeconomic equilibrium in AD-AS model.

Variants of macroeconomic equilibrium

Variants of macroeconomic equilibrium
If aggregate demand changes within the Keynesian segment, then the growth of demand leads to an increase in real domestic production and employment at constant prices (B).
If aggregate demand grows in the intermediate period, it leads to an increase in real GDP, prices and employment (C)
If aggregate demand grows in the classic segment of AS, it leads to inflationary growth in prices and nominal GDP with constant real GDP (because, as already noted, it can not grow more than the level of "full employment")(A)