LEARNING OBJECTIVES MACRO ECONOMIC

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1 12.2A LEARNING OBJECTIVES MACRO ECONOMIC EQUILIBRIUM An analysis of the use of AD and AS in macro equilibrium Define aggregate demand and aggregate supply Describe the components of aggregate demand/supply Analyse the difference effects of changes in aggregate demand and aggregate supply TASK TEAM OBJECTIVES Read the Subject Programme instructions 1) Design a brief lesson paying attention to the learning objectives given to you. 2) Deliver the lesson 3) Ensure that you have included a short activity to check learner s understanding of the topic (You have 15 minutes to deliver your lesson) DEMAND A comparison between Micro and Macro economy REVIEW So what do you remember about demand analysis? What about market supply? REVIEW EXERCISE USE DEMAND AND SUPPLY ANALYSIS to clarify (explain) the general impact of a current event on equilibrium prices and quantities. CREATE your own event! 1

2 GROUP EXERCISE Event: The WSJ reports that the prices of PC components are expected to fall by 5-8 percent over the next six months. Scenario 1: You manage a small firm that manufactures PCs. Scenario 2: You manage a small software company. Perform a Demand/ Supply Analysis to show the effects of each of these on the market Market demand vs Aggregate Demand MARKET DEMAND AGGREGATE DEMAND micro macro Market demand vs Aggregate demand Market Demand vs Aggregate Demand MARKET DEMAND Refers to consumers willingness to buy a SINGLE PRODUCT C AGGREGATE DEMAND Refers to ALL BUYERS ability to buy ALL GOODS (total real GDP) produced in the economy C G I Nx MARKET DEMAND AGGREGATE DEMAD DOWNWARD SLOPE Let s draw the curves now. THE MACRO ECONOMY Investigating AGGREGATE DEMAND and QUESTION? How does the macro economy equilibrium differ from the micro economy? 2

3 AD and AS AD - represents the demand side of the economy. AS represents the supply side Some thoughts The AD/AS model represents all goods and not just one single good. Real GDP It takes into account the price level of all goods aggregate output of the economy. Aggregate Demand Definition Aggregate means total AGGREGATE DEMAND Aggregate demand is the demand for the gross domestic product (GDP) of a country, and is represented by this formula: Aggregate Demand (AD) = C + I + G + (X-M) COMPONENTS OF AD C + I + G + (X-M) C = Consumers' expenditures on goods and services. I = Investment spending by companies on capital goods. G = Government expenditures on publicly provided goods and services. X = Exports of goods and services. M = Imports of goods and services. 3

4 : SLOPE OF THE AD CURVE There is a negative relationship between aggregate demand and the price level. Aggregate demand rises as the price level falls. EFFECT OF PRICE CHANGES ON AD Cause MOVEMENTS UP OR DOWN the curve MOVEMENT UP OR DOWN CURVE CAUSES: Wealth EFFECT INTERNATIONAL Interest rates so how do these factors effect aggregate demand? Interest? Wealth? International activity? AD is the same in REMEMBER both the short run!!! and the long run. Aggregate Demand represents how a change in a certain price level will change expenditures on all goods and services in an economy 4

5 FACTORS THAT SHIFT AD FACTORS THAT SHIFT AD ChaChanges in consumer confidence/ changes in interest rates/ changes in wealth/ changes in income tax/ changes in household debt Changes in business confidence/ changes in interest rates (MONETARY POLICY)/ changes in technology/ chances in business taxes/changes in the level of business debt Changes in political priorities/ deliberate actions to affect Aggregate Demand (FISCAL POLICY) Changes in national income overseas/ changes in exchange rates/ changes in trade protection Aggregate Supply DEFINITION Aggregate supply (AS) measures the amount of goods and services produced within the economy at a given price level. describes the relationship between price levels and the quantity of output that firms are willing to provide. Normally, there is a positive relationship between aggregate supply and the price level. 5

6 Rising prices are usually signals for businesses to expand production to meet a higher level of aggregate demand. LRAS vs SRAS Different or the same? HIGH PRICES Increase (A)SUPPLY Aggregate DEMAND What is the difference? W H Y It consists of: Long-run Aggregate Supply (LAS) represents the MAXIMUM output that an economy can sustain (put up with). Short-run Aggregate Supply (SAS) represents the supply of goods of the economy in the short run (usually 1 year). SHORT RUN < One year LONG RUN > One year AS represents the ability of an economy to deliver goods and services to meet demand SHORT RUN vs LONG RUN In the short run, aggregate supply responds to higher demand (and prices) It brings more inputs into the production process and increasing the use of current inputs. In the long run, aggregate supply is not affected by the price level It is driven only by improvements in productivity and efficiency. 6

7 SHORT RUN ONLY two variables CETERIS (PRICE LEVEL and PARIBUS REAL AGGREGATE PRODUCTION) change Everything else eg wages and technology remains constant SRAS is an UPWARD SLOPING CURVE SHORT RUN AS Shifts of the short-run aggregate supply curve can be brought about by such things as: technology, changes in wages changes in other resource prices changes in resource quantities. (AS) The Long-Run Aggregate Supply (LAS) no input prices are assumed to be constant. Thus, LAS is a representation of potential output. LONG RUN AS The LAS curve is vertical. It shows potential output. All prices, even input prices, rise when a rise in price level occurs. LRAS Since the LAS is POSSIBLE output it is shifted by the factors which affect potential output As these LRAS SHIFTS FACTORS THAT AFFECT LRAS available resources capital entrepreneurship technological developments CURVES 7

8 The 3 ranges of So how does the SHORT RUN become LONG RUN? MOVING FROM SHORT RUN TO LONG RUN Moving from Short-run to Long-run In the short-run, the price level of the economy is sticky or fixed depending on changes in aggregate supply. Also, capital is not fully mobile between sectors. In the long-run, the price level for the economy is completely flexible in regards to shifts in aggregate supply. There is also full mobility of labor and capital between sectors of the economy. The aggregate supply moves from short-run to long-run when enough time passes such that no factors are fixed. That state of equilibrium is then compared to the new short-run and long-run equilibrium state if there is a change that disturbs equilibrium. QUESTION 1) Does the level of aggregate supply remain the same in the short run? 2) Analyse the impact of inflation and unemployment on SRAS 3) Is it possible to lower unemployment by raising inflation? 8