Editors Note:
McConnell Economics Books, including the
18th edition,
are one of many sources of material included in this chapter.
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I. Macro equilibrium
A. Macro equilibrium exists when
the demand and supply variables affecting total economic activity are in balance and
under no
pressure to change
1. Demand variable total to
Aggregate Demand
2. Supply variables total to
Aggregate Supply
B. Macro equilibrium exists even though
the more slowly changing variables affecting long-term
activity are still in flux.
Said long-term activity is called a long-term
secular trend.
II. Aggregate demand (AD)
A. Aggregate demand is
a schedule matching the Real Gross Domestic Product a country purchases at
various price levels.
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As prices drop, the amount of
real gross
domestic product purchased (AD) increases.
AD = C + I + G + XN
Like all demand curves, AD increases to the right
and decreases to the left.
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B. Price level is the key determinate of
aggregate demand. Holding non-price level determinants constant yields
the
following analysis of why price levels and aggregate
demand are inversely related. That is, as prices decrease, Real GDP increases.
1. Interest rate effect
a. If the price (inflation) is low, interest rates will be low.
b. Low interest rates will cause
consumption and investment to be high increasing AD.
c. This is especially true now that home mortgages are easily refinanced at
lower interest rates.
2. Real asset balance effect
a. When inflationary expectations are low, people think their past accumulations
(savings) will maintain their value.
b.
This feeling results in
people spending more which increases AD.
3. Low domestic inflation relative to foreign inflation results in low-priced
exports selling better which increases AD
4. High price levels will bring opposite results
C. Non-price level determinants of aggregate
demand and
their determining characteristics
1. Consumption (C)
a. Wealth, if expected to increase, increases consumption.
b. Expectations, like more overtime, increase consumption.
c. Debt decreasing like refinancing a home at lower
interest increase consumption.
d. Taxes, if lowered, increase consumption.
2. Investment (I)
a. Profit expectations, if high, increase investment.
b. Business taxes, if decreased, increase investment.
c. Excess capacity, if low, increases investment.
d. Technology outlook, if positive, increase investment .
3. Government Spending (G)
4. Net
Exports (XN) (exports minus imports)
a. Economic activity abroad
b. Exchange rates
D. Price level and non-price level factors
together determine aggregate demand which interacts with aggregate supply
to determine total economic activity.
III. Aggregate supply (AS)
A. Aggregate Supply is a schedule of the amounts of Real Gross Domestic
Product companies are willing to produce
at various
price levels. Holding non-price
determinants constant yields
the following analysis of how different price
levels affect AS.
1. Keynesian Range: increases in AD increase real GDP and prices do not
change
2. Intermediate Range: both prices and real GDP change
3. Classical Range: increases in AD increases prices and real
GDP does not change because full employment exists
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Like all supply curves,
AS increases to the right and decreases to the left. |
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B. Non-price factors affecting aggregate supply
1. Factor prices: decrease in factor
prices will increase AS
2. Productivity: increases in
productivity will increase AS
3. Domestic and foreign tranquility
will increase AS
IV. Static equilibrium is where AD
and AS intersect
V. Dynamic equilibrium depicts
changes in AD and AS over time
A. GDP grows to Q'.
B. Prices increase to P'.
VI. Demonstrations
A.
The Aggregate Demand
and Aggregate Supply Model by Dennis Kaufman of
the University of Wisconsin-Parkside
B.
Aggregate Demand and Aggregate
Supply
model
VII.
US macro disequilibria (Oct 2008)
Note: There are no questions associated with this chapter as the material
will be reexamined and questions posed in the next few chapters.