Lecture Issues in economics today - Chapter 8

When you finish this chapter, you should: Define the key terms of economics and opportunity cost and understand how a production possibilities frontier exemplifies the trade-offs that exist in life, distinguish between increasing and constant opportunity cost and understand why each might happen in the real world, analyze an argument by thinking economically, while recognizing and avoiding logical traps.
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Lecture Issues in economics today - Chapter 8 Chapter 8 Aggregate Demand and Aggregate Supply McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved. Chapter Outline • Aggregate Demand • Aggregate Supply • Shifts in Aggregate Demand and Aggregate Supply • Causes of Inflation • Supply-Side Economics McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved. Aggregate Demand • Aggregate Demand: the amounts of real domestic output which domestic consumers, businesses, governments, and foreign buyers collectively will desire to purchase at each possible price level McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved. Figure 1 Aggregate Demand PI AD RGDP McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved. Why Aggregate Demand is Downward Sloping • Real Balances Effect – Because higher prices reduce real spending power, prices and output are negatively related. • Foreign Purchases Effect – When domestic prices are high, we will export less to foreign buyers and we will import more from foreign producers. Therefore higher prices leads to less domestic output. • Interest Rate Effect – higher prices lead to inflation which leads to less borrowing and a lowering of RGDP McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved. Aggregate Supply • Aggregate Supply: the level of real domestic output available at each possible price level McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved. Figure 2 The Aggregate Supply Curve PI Classical Range Intermediate Range Keynesian Range RGDPMcGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved. The Ranges of AS • Keynesian Range – Large amounts of unemployment make it so that increases in aggregate demand have no affect on wages or prices. • Classical Range – Full employment makes it so that increases in aggregate demand only increase wages or prices. • Intermediate Range – Some sectors of the economy reach full employment more quickly than others. McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved. Variables that Shift Aggregate Demand • Taxes • Interest Rates • Confidence • Strength of the Dollar • Government Spending McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved. Determinants of AD Variable GDP Component Effect of an Effect of a Affected increase on decrease on C,I,G,X AD AD Taxes C,I Decrease so Increase so AD Interest Rates C,I Decrease so Increase so AD Confidence C,I Increase so Decrease so AD => AD AD Figure 3 AD Increases PI AS PI’ PI* AD’ AD RGDP* RGDP’ RGDP McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved. Figure 4 AD Decreases PI AS PI* PI’ AD AD’ RGDP’ RGDP* RGDP McGrawHill/Irwin ©2002TheMcGrawHillCompanies,Inc.,AllRightsReserved. Variables that Shift AS • Input Prices • Productivi ...