Aggregate demand curve
How do aggregate demand and aggregate supply differ from demand and supply? Aggregate demand curve Y = A . F (K,LH,N) tells us who’s buying the stuff we’re making Y = C + I + G + NX how we combine inputs to produce the outputs AD: Y = C + I + G + NX (everything we produce, taking net exports production in other countries) The AD curve has a negative slope for three reasons: 1. Wealth effect 2. Interest rate effect 3. Real exchange rate effect Demand curve: Substitute goods; ad: already including everything, what can you sub 1. Wealth Effect
Price goes down people feel wealthier they shop more consumption spending goes up Y ^ = C^ + I + G + NX
2. Interest rate effect
(ch 15) 2 financial assets: money (doesn’t pay interest), bonds (do pay interest) o holding money is expensive, giving up the money you could be earning on a bond : opportunity ccost o opportunity cost of holding money = interest rate
price levels go down but people don’t want to buy more stuff, want to buy the same amount of stuff they were buying o if buying the same quantity and the prices are now lower don’t need as much money (money demand curve shifts left, int rate goes down) o when interest rate goes down, investment goes up so Y goes up
3. Real exchange rate effect
price goes down, (eP/P*) real exchange rate goes down canadian goods become less expensive we import less (sub away from expensive foreign goods) exports increase, more people want canadas products NX ^ so Y ^ Moving along the aggreagate demand curve
Shift factors for the AD curve Anything other than P that affects C, I, G or NX will cause the AD curve to shift Decrease in consumption, cause AD curve to shift down to the left Changes in P are along the curve Aggregate Supply Long run aggregate suply LRAS: Y = A.F(K.L.H.N) Classical dichotomy: In the long run, real variable are not affected by the money supply, changes in the MS only affect nominal variables Long run aggregate supply curve: o Slope: A, K L , H, N do no depend on price (classical dichotomy – the long run separation of real and nominal variables) o LRAS is vertical o Shift: any change in A, K, L, H, or N will cause the LRAS curve to shift o No realtion with price and output; nominal wages move along the price
Short run aggregate supply SRAS: Y = ^Y (the hat ontop of Y) + a(P-P^e) (p to the power e) o The slope is positive for three reasons 1. Sticky wage theory i. 2. Sticky price theory 3. Misperceptions theory Shift: the SRAS curve will shift when the LRAS curve shifts or when people’s expectation of the price level changes Nominal wages (number of dollars you get paid) are (Fixed for atleast ½ years) sticky fixed in the short run, flexible in the long run If price of goods and servies goes down, and the number of dollars we are being paid is the same real wage goes up (labour becomes expensive – price of an input goes up, firms will cut production) Y goes down
The complete model
Price goes down people feel wealthier they shop more consumption spending goes up Y ^ = C^ + I + G + NX
2. Interest rate effect
(ch 15) 2 financial assets: money (doesn’t pay interest), bonds (do pay interest) o holding money is expensive, giving up the money you could be earning on a bond : opportunity ccost o opportunity cost of holding money = interest rate
price levels go down but people don’t want to buy more stuff, want to buy the same amount of stuff they were buying o if buying the same quantity and the prices are now lower don’t need as much money (money demand curve shifts left, int rate goes down) o when interest rate goes down, investment goes up so Y goes up
3. Real exchange rate effect
price goes down, (eP/P*) real exchange rate goes down canadian goods become less expensive we import less (sub away from expensive foreign goods) exports increase, more people want canadas products NX ^ so Y ^ Moving along the aggreagate demand curve
Shift factors for the AD curve Anything other than P that affects C, I, G or NX will cause the AD curve to shift Decrease in consumption, cause AD curve to shift down to the left Changes in P are along the curve Aggregate Supply Long run aggregate suply LRAS: Y = A.F(K.L.H.N) Classical dichotomy: In the long run, real variable are not affected by the money supply, changes in the MS only affect nominal variables Long run aggregate supply curve: o Slope: A, K L , H, N do no depend on price (classical dichotomy – the long run separation of real and nominal variables) o LRAS is vertical o Shift: any change in A, K, L, H, or N will cause the LRAS curve to shift o No realtion with price and output; nominal wages move along the price
Short run aggregate supply SRAS: Y = ^Y (the hat ontop of Y) + a(P-P^e) (p to the power e) o The slope is positive for three reasons 1. Sticky wage theory i. 2. Sticky price theory 3. Misperceptions theory Shift: the SRAS curve will shift when the LRAS curve shifts or when people’s expectation of the price level changes Nominal wages (number of dollars you get paid) are (Fixed for atleast ½ years) sticky fixed in the short run, flexible in the long run If price of goods and servies goes down, and the number of dollars we are being paid is the same real wage goes up (labour becomes expensive – price of an input goes up, firms will cut production) Y goes down
The complete model
