CFA 1 Economics-II

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Economics - II
Mapping to Curriculum
Reading 17: Aggregate Output, Prices, Economic Growth, Fiscal balance, Trade balance, Long run equilibrium and disequilibrium, Aggregate Demand curve Reading 18:Understanding Business cycle Reading 19: Monetary and Fiscal Policy
This files has expired at 30-Jun-13 Expect around 8 questions in the exam from todays lecture
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Key Concepts
Aggregate demand Renewable and Non-renewable Resource-Supply Curve Views Of Different Schools Of Macroeconomics On Macroeconomic Equilibrium Types and Measurement of Unemployment Factors that affect Price Level Quantity Theory of Money Fiscal Policy
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GDP Using Income And Expenditure Methods

Given GDP as Y = C + I + G + NX, investment is major component of GDP Investment is amount incurred to buy fixed productive assets and inventory which generates income Hence when investment declines less output is generated and less capital is created causing the growth rate in real GDP to fall. Sources of financing for investment are Private Sources National savings Borrowing from foreigners, Government Sources
Govt Savings (surplus) = Tax revenue government expenditure
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GDP, National Income, Personal Income And Personal Disposable Income

The major component of real GDP are as follows: Consumption Business Investment Government Purchase Net Export (Export- Import) GDP : National Income+ Capital Consumption + Statical Discrepancy Capital Consumption Allowance: It measure the depreciation of physical capital from the production of goods and services. National Income: It the sum of income received by all factor of production that go into creation of final output
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Compare The Sum Of Value Added And Value Of Final Output Method For GDP Calculation
The Expenditure approach to measuring GDP can be use for both the following methods for calculation of the GDP. Sum of Value Added: The GDP is calculated by summing the addition to value created at each stage of production and distribution. Value of Final Output: GDP is calculated by summing the value of all final goods and services produced during the period.
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Nominal And Real GDP, Calculate GDP Deflator

Nominal GDP: The total value of all goods and services produced by an economy, valued at current market price
(price of good i in current year) (quantity of good i produced in current year)

Real GDP: Real GDP measure the output of the economy using the prices from base year
(price of good i in base year) (quantity of goods i produced in current year)

GDP Deflator: It is a price index that can be used to convert nominal GDP into real GDP, taking out files has Itexpired 30-Jun-13 the effect of change inThis the overall price level. is based on at the actual mix of goods and services produced in the base year.
Value of Current year GDP at current year prices 100 Value of Current year GDP at base year prices
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GDP, National Income, Personal Income And Personal Disposable Income

Personal Income: It is the pretax income received by household and is one determinant of consumer purchasing power and consumption. It include the following: Add: National Income Add: Transfer payment Less: Indirect Business Taxes Less : Corporate Income Taxes Less: Undisputed Corporate profits

Personal Disposable income: = Personal Income - Personal Taxes It is the personal disposable income after tax. PDI measure the amount that available to either save or spend on goods and services.
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Relationship Among The Saving, Investment, Fiscal Balance, And Trade Balance
Fiscal Balance:
The balance of a government's tax revenues, plus any proceeds from asset sales, minus government spending. If the balance is positive the government has a fiscal surplus, if negative a fiscal deficit.
Balance of Trade:
The balance of trade (or net exports, sometimes symbolized as NX) is the difference between the monetary value of exports and imports of output in an economy over a certain period. It is the relationship between a nation's imports and exports. A positive balance is known as a trade surplus if it consists of exporting more than is imported; a negative balance is referred to as a trade deficit or, informally, a trade gap.
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Relationship Among The Saving, Investment, Fiscal Balance, And Trade Balance
Factors that can affect the balance of trade include:
The cost of production (land, labor, capital, taxes, incentives, etc.) in the exporting economy vis--vis those in the importing economy; The cost and availability of raw materials, intermediate goods and other inputs; Exchange rate movements; Multilateral, bilateral and unilateral taxes or restrictions on trade; Non-tariff barriers such as environmental, health or safety standards; The availability of adequate foreign exchange with which to pay for imports; and Prices of goods manufactured home (influenced by the responsiveness of supply) This atfiles has expired at 30-Jun-13 Private saving and investment are related to the fiscal balance and the trade balance. A fiscal deficit must be financed by some of a trade deficit or an excess of private saving over private investment.
(G-T) = (S-I) (X-M)
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IS And LM Curve And Combine Them To Generate The Aggregate Demand Curve
The IS curve shows the negative relationship between the real interest rate and level of aggregate income that are equal to planned expenditure at each real interest rate. The LM curve shows, for a given level of the real money supply, a positive relationship between the real interest rate and level of aggregate income at which demand and supply of real money balance are equal. The point at which the IS curve intersect LM curve for different level of the real money supply from the aggregate demand curve. The aggregate demand curve shows the negative relationship between GDP and the price level when all the other factor are constant
The IS and LM curve
Real interest rate
This files has lower expired at 30-Jun-13 LM curve, M/P

(higher P) LM Curve
A B C
LM curve, higher M/P (lower P)
IS Curve Real income
YA
YB
YC
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External Economies/ Diseconomies Of Scale

External economies / diseconomies depends on the slope of LRAC curve Downward LRAC external economies Additional demand will increase output, but will reduce the price Upward LRAC external diseconomies Additional demand will increase output, but will increase the price Increased demand for productive inputs leading to an increase in the prices
Will result in an increase in equilibrium price and output
Price SRS 0 This files has expired at 30-Jun-13 SRS1 PSR PLR P0 D1 D0 Quantity LRS
External Diseconomies of scale

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Why LAS Is Vertical Line While SAS Is Upward Sloping

SAS is upward slopping as supply increases at higher prices in the short run LAS is vertical as it is not affected by the price level LAS is the potential (full-employment) real output of the economy.
Price Level
The level of real GDP on the LAS curve is the

Long run Aggregate supply (SAS) Short run Aggregate supply (SAS)
economy's level of production when the economy is

operating at full employment Over time, the LAS curve may shift: As the full-employment quantity of labor changes,
As the amount of available capital in the economy

Real O/P (GDP) Full Employment Real O/P
changes, or As technology improves the productivity of capital, labor, or both
Aggregate supply in Long run and Short run
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Components Of Aggregate Demand

Aggregate demand = C + I + G + X The aggregate demand curve shows the relation between the price level and the real quantity of final goods and services (real GDP) demanded Aggregate demand curve is downward sloping,
Consumption, investment, and exports will decrease as price increases Change in the price level cause changes in aggregate demand
Here, there are two effects:

Wealth effect: Rising price levels decreases individuals' real wealth they will spend less decrease in demand This files has expired at 30-Jun-13 Substitution effect: Rising price levels increases interest rates decreases I as well as C
Three factors shifting the aggregate demand curve:

Expectations about future incomes (C), inflation (C), and profits (I) Fiscal and monetary policy (expansionary or restrictive) World economy
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Factors That Influence The Demand Of Capital

Financial capital: The money raised through issuing securities Physical capital: The physical assets of a firm, including PP&E, inventory The greater the demand for physical capital, the greater the demand for the financial capital necessary to purchase the physical capital For profit-maximizing firm: MRPLabor = wage rate; MRPCapital = cost of capital A profit-maximizing firm will employ additional physical capital until MRP = cost Where Cost = interest rate on funds
Demand for financial capital will be a downward sloping function of the interest rate (the cost of financial capital) Less demand at high interest rates With physical capital (e.g. machinery), the additional output will come over many periods into the future PV (Future MRP of capital) will determine the return on a current investment in (physical) capital assets
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Factors That Influence The Supply Of Capital

Supply curve will be an upward sloping function of interest rates Increased supply at higher interest rates Suppliers of capital are savers choice of consuming now or later. 3 factors that influence the supply of capital Interest rates Income Expected future income increases
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Long-run Equilibrium
Long-run equilibrium is where LAS curve intersects Aggregate Demand curve
LAS Price Level (Index) Excess Supply 115
Excess supply (recessionary gap) puts downward pressure on prices causing fall in production which moves the economy toward long-run equilibrium Excess demand (Inflationary gap) causes increasing output and prices which again moves economy toward long-run equilibrium
AD
110
105
Excess Demand
This files has expired 30-Jun-13 Changes in at the price level of final goods and services can
Real GDP
move the economy to long-run macroeconomic equilibrium
An Increase in Potential GDP
Equilibrium is at a price level of 110
If we are at a short-run disequilibrium (price level at 115), there is excess supply which puts downward
pressure on prices. Businesses will see a build-up of inventories and will decrease both production and prices levels in response moving the economy toward long-run equilibrium (price level of 110) If the price level were 105, there would be excess demand for real goods and services. Businesses will
experience unintended decreases in inventories and respond by increasing output and prices. This moves
economy along the aggregate demand curve toward long-run equilibrium
Long-Run Disequilibrium
Long-run disequilibrium arises when level of output is above or below full-employment GDP
Recession (below full employment): Shortrun equilibrium real GDP (GDP1) is less than full employment GDP (along the LAS curve). It brings downward pressure on money wages and resource prices that will decrease the equilibrium price level from P1 to P* Expansion (over full employment): In expansion, short-run equilibrium real GDP, GDP1, is above the full-employment level when aggregate demand has grown faster than LAS. The result will be upward pressure on prices that will result in inflation as the general price level increases from P1 to P*
LAS SAS1 Price Level (Index) SAS1
Long Run (Above full employment) This has expired atequilibrium 30-Jun-13 Long Run equilibrium (belowfiles full employment)
Price Level (Index) LAS
P1 P* P*
P1
AD1 AD1 Real GDP GDP1
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Real GDP GDP1

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Adjustment To An Increase In Aggregate Demand (AD)

Increase in AD pushes new SR equilibrium at above full employment and real wages to fall From an initial state of long-run equilibrium at the intersection of AD0 with LAS, assume that aggregate demand increases to AD1. The new short-run equilibrium will be at over-full employment with real GDP at GDP1
SAS1 Price Level LAS SAS0
The increase in the price level (from P0 to PSR ) at
new equilibrium level means that workers' real wages

have decreased (holding money wages constant in SR)
This files has expired at 30-Jun-13 Increase in demand will have no impact on LR
PLR PSR P0 AD1 AD0
macroeconomic equilibrium
Increase in demand will cause businesses to attempt

to increase production by hiring more workers increased money wage demands shift in the SAS curve from SAS0 to SAS1
GDP* GDP1 Real O/P GDP
This will restore LR macroeconomic equilibrium at full-employment real GDP and at a new price level of PLR
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Adjustment to an increase in aggregate demand
Adjustment To A Decrease In Aggregate Demand

Decrease in AD will have opposite impact Decrease in AD from AD0 to AD1 will lead to a new short-run equilibrium with the price level at PSR and real GDP at GDP1 which is less than full-employment GDP (a recession)
SAS0
Price Level LAS SAS1
Resulting excess supply of labor (workers
seeking jobs) will put downward pressure on

money wage rates and other resource prices
P0 PSR PLR
shift in SAS SAS1 (an increase in supply), This files has expired at to 30-Jun-13 restoring long-run equilibrium at fullAD0
employment GDP along the LAS curve and at a new, lower price level (PLR )
AD1
Real O/P GDP GDP1 GDP*
Adjustment to a decrease in aggregate demand
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Sustainability Of Economic Growth

One way to view Potential GDP :
Potential GDP aggregate hours worked Labor productivity

Or in terms of economic growth
Potiential GDP : growth in labor force growth in labor productivity

The sustainable rate of economic growth is important because long-term equity returns are highly dependent on economic growth over time. A countrys sustainable rate of economic growth is the rate This productive files has expired at 30-Jun-13 of increase in the economys capacity.
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Equilibrium In Capital Market

Interest rates are decided where supply of capital intersects demand of capital
Interest Rate
Supply of Financial Capital
rC

Demand for Financial Capital
QC
Quantity of Financial Capital
Capital Market Equilibrium
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Renewable And Non-renewable Resources Supply Curve

Renewable sources are replenished by nature. E.g. Water Supply at a point in time, or per time period, is fixed independent of price Non Renewable is either not replenished or at very slow rate. E.g. Oil Rate of supply, also called "flow supply" is perfectly elastic at price that equals the present value of the expected next-period price
Price

S P*
P*
Price
D D Q* Quantity Q* Quantity
Supply Curve - Non-Renewable Resource (Oil Well)
Supply Curve - Renewable Resource (Water well)
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Input Growth And Total Factor Productivity As Component Of Economic Growth

Growth in Potential GDP = Growth in technology + Growth in Labor + Growth in Capital
In developed countries, a high level of capital per worker is available and capital inputs experience diminishing marginal productivity, technology advances that increase total factor productivity are the main source of sustainable economic growth.
Technological advances are the discoveries that make it possible to produce more and higher quality goods and services with some resources or inputs. Technology is the main factor affecting economic growth in developed countries. This files has expired at 30-Jun-13 The sustainable rate of growth in an economy is determined by the growth rate of the labor supply plus the growth rate of labor productivity.
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Questions (Test 1)
1. The country Saunderland is examining its resources to chalk out a strategy of growth. Which of the following is a most likely classification of its resources
Renewable Resources Nonrenewable resources
A B
Land Water
Water Coal
Labor
Land

2. Supply curve is perfectly elastic for: A. renewable resource B. non-renewable resource C. both renewable & non-renewable resource
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Questions
3. Which of the following factor is expected to increase demand elasticity of labor A. Short time period B. High degree of substitution C. Less labor intensive production process 4. Monopsony is least expected to cause A. Deadweight loss B. Payment of wage rate equal to MRP C. Employer to hire less workers than required This files has expired
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5. For a renewable resource A. Supply curve is perfectly elastic with zero economic profit B. Supply curve is perfectly inelastic with zero economic profit C. Supply curve is perfectly inelastic with entire payment is economic profit
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Solutions
1. B. Resources like land, rivers and lakes are natural resources that are renewable while coal, oil and other similar resources are non renewable; i.e. They cannot be replenished once they are used up. 2. 3. 4. 5. B. Supply curve is perfectly elastic for a non-renewable resource only B. labor will be highly elastic if it can be substituted through automation. B. In monopsony situation employer pays the wage less than wage rate (as implied by MRP) C. Renewable resources price are determined by demand curve with supply curve remains perfectly inelastic causing entire payment to be economic profit.
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Agenda
Aggregate Output, Prices, Economic Growth, Fiscal balance, Trade balance, Long run equilibrium and disequilibrium, Aggregate Demand curve Theories of business cycle and its phases, measurement of unemployment, Inflation, disinflation, Factors that affect price levels and Economic indicators. Monetary and Fiscal Policy
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The Business Cycle And Its Phases

Business cycle refers to economy-wide fluctuations in economic activity or production over a time. Growth rate of real gross domestic product and unemployment rate is used to determine current stage of business cycle In Expansion
Inflation exists Real GDP growth is positive Unemployment is falling
Real GDP Average Business Peak

Expansion Contraction (Recession)
In Recession
Deflation (negative inflation) exists
Negative Real GDP growth rate

Increasing unemployment
Recessionary Trough
Time
Business Cycle
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Views Of Different Schools Of Macroeconomics On Macroeconomic Equilibrium

Classical economists:
Technological changes are primary driver of shift in both AD & AS Long-run adjustment of money wages to restore full-employment equilibrium happens fairly rapidly
Since the economy has a strong tendency toward full-employment equilibrium,
Recession or over-full employment change the money wage rate Taxes are the primary barriers to long-run equilibrium
If distortions in incentives from taxes were minimized, the economy would grow in an efficient manner due to increases in labor and capital and improvements in technology
Failure of Classical view:

In great depression of the 1930s economy in the U.S. operated significantly below its full-employment level for many years Business cycles in general were more severe and more prolonged than suggested by classical model
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Views Of Different Schools Of Macroeconomics On Macroeconomic Equilibrium (Cont)

Keynesian school of macroeconomics: Economist John Maynard Keynes provided policy recommendations for moving the economy toward full-employment GDP and reducing the severity and duration of business cycles Keynesian economists: Changes in expectations are primary cause of shifts in AD & business cycles
Wages are downward sticky, reducing the ability to decrease money wages and increase SAS to move the economy from recession (or depression) back towards the full-employment level of output.
New Keynesians added : Prices of other productive inputs besides labor are also downward sticky another barrier to the restoration of full-employment equilibrium Keynesian economists suggested to use monetary policy (increasing the money supply) or fiscal policy (increasing government spending, decreasing taxes, or both) to increase AD
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Views Of Different Schools Of Macroeconomics On Macroeconomic Equilibrium (Cont)

Monetarist economists:
Monetary policy is primary reason for business cycles & deviations from full-employment equilibrium
Recessions occurs due to inappropriate decreases in money supply Recessions can be persistent because money wage rates are downward sticky (Keynesians). Central bank should do steady & predictable increases in money supply Surprise inflation creates bias in the economy

Best tax policy is to keep taxes low (Classical) keep AD stable and growing
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Mainstream Business Cycle Theory

Price Level
LRAS1 SRS1
Mainstream Business Cycle Theory:

Change in aggregate demand causes business cycle to occur If growth in AD > Potential Real GDP growth = Inflationary Gap occurs If growth in AD < Potential Real GDP growth = Recessionary Gap
ADH AD1
occurs
ADL GDPL GDP1 GDPH
Real GDP
RBC theory believes that increase in productivity drives the economy and causes fluctuation in growth rate of Potential Real GDP
Hence increasing productivity => expansion Hence fall in productivity => recession
Differences between Mainstream and RBC:

Mainstream says that potential real GDP grow slowly and steadily whereas RBC believes fluctuation in potential real GDP Mainstream says AD causes business cycle to occur whereas RBC assumes productivity is the cause
Types And Measurement Of Unemployment

Cyclical unemployment (C.U.): Caused by changes in the general level of economic output especially when economy is not operating at 100% capacity Frictional unemployment (F.U.) : Is unemployment resulting from job search activity
Qualified workers not matched with existing job openings puts their time and efforts for right opportunities causing FU
Structural unemployment (S.U.): Caused by (structural) changes in the economy that eliminate some jobs (Unemployed workers do not have the skills to perform the newly created jobs)
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Types And Measurement Of Unemployment

Full employment: when the economy has no cyclical unemployment
Structural & Frictional unemployment continue to exist
Natural rate of unemployment : frictional unemployment + structural unemployment Relationship between GDP and Unemployment
If real GDP < potential GDP cyclical unemployment . If real GDP > potential GDP cyclical unemployment
Potential GDP: The (theoretical) level of output the economy can produce when unemployment is at the natural rate
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Unemployed And Labor Market Indicator
Total Population Work-Age Population (>16 years)
Labor Force Employed
Unemployment Rate : [(number of employed) / (labor force)] * 100 Labor force participation rate = [(labor force) / (working population)] * 100 Employment-to-population ratio = [(no. of employed) / (working population)] * 100
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Aggregate Hours, Real Wage Rates, And Relation To GDP

Aggregate hours are total number of hours employed by all employees in a year
Output produced / aggregate hours estimates the labor productivity
Employees with higher labor productivity will get higher wage rate
Aggregate hours, though have shown long term trend, have not grown as labor force
Due to declining average workweek which is weekly hours per person
Both aggregate hours & work week tend to increase during expansions & decrease during recessions.
Real wage rates

Measures what an hour's labor is paid in terms of goods & services Are money wage rates adjusted for changes in the overall price level Fluctuate with the productivity of labor & calculated using total labor compensation including wages, salaries and employer-paid benefits.
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Factors That Affect Price Levels:

Price level are affected by real factors and monetary factors.
Real Factors include aggregate supply (an increase in supply leads to lower prices) and aggregate demand (an increase in demand lead to higher prices)
Monetary factors includes the supply of money (more money circulating if the economy is in equilibrium, will lead to higher prices) and the velocity of money (higher velocity if the economy is in equilibrium, wiil again lead to higher prices)

The major factor are as follows:
Demand Pull Inflation Cost-Push Inflation
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Demand-pull Inflation
Increases Price Level from P1 to P3 AD increases (shifts to the right) when money supply increases, causing GDP to increase to GDP2 above Full employment GDP Price increase to P2 but this Temporary and economy returns to equilibrium with GDP1 causing price level to increase further at P3.
Price Level LRAS
This SRAS2 files has

SRAS1
Increases Price Level from P1 to P3 Reduction in supply of important production factors or resources causes SRAS1 to move to SRAS2 which increases the price level to P2 and reduces output to GDP2. However AD increases due to policy reforms which causes GDP returns to its long term potential at GDP1 and Prices to move to P3 level expired at 30-Jun-13
SRAS2 Price Level LRAS SRAS1
P3 P2 P1 AD2 AD1 P3 P2 P1 AD2 AD1
GDP1 GDP2
Demand Pull Inflation

Real GDP
GDP2 GDP1
Real GDP
Cost Pull Inflation

Construction Of Indices Used To Measure Inflation

To calculate the rate of inflation, we need to use a Price index. The Consumer price index is the best known indicator of US inflation.
CPI
Cost of basket at current prices 100 Cost of basket at base period price
An alternative measure of consumer price inflation is the price inflation is the price index for personal consumption expenditure.

Widespread price increase for producer goods may be passed along to consumer. For most major economies, a producer price index(PPI) or wholesale price index (WPI) is available.
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Compare Inflation Measure, Including Their Uses:

Major Factors of Laspeyres Index of consumer price to be biased upward as a measure of the cost of living
New Goods Quality Change Substitution
A technique called hedonic pricing can be used to adjust a price index for product quality.
files has expired at A paasche price indexThis uses current consumption weights for the30-Jun-13 basket of goods and services for both periods and thereby reduces substitution bias. A Fisher price index is the geometric mean of a Laspeyres and Passche index.
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Costs Of Anticipated Inflation

High anticipated inflation causes:
Low real growth rate of GDP Low economic output
Because it:
Decreases transaction value and store value of money possible People move resources to deal with inflation put their time and efforts into unproductive acts moving from productive acts Decreases investment as return on investment distorted taking into account of inflation rational response is to spend as rapidly as
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Economic Indicators, Their Uses And Limitations:

Economic Indicator can be classified into 3 categories:
Leading Indicator: It have been known to change direction before peaks or through in a business cycle Co-incidence Indicators : It change the direction at roughly the same time as peak or troughs Lagging indicators: It dont tend to change direction until after expansions or contraction are already underway
An economic indicator is a variable that provide information on the state of overall economy.
Economic indicator classification: This files has expired at 30-Jun-13

Leading economic indicator have turning point that usually precede those of the overall economy, they are believed to have value for predicting the economy future state (usually near term) Co- incident economic indicator: have turning point that that are usually close to those of the overall economy they are believed to have value for identifying the economy Present State Lagging economy indicator: have turning point that take place later than those of the overall economy. They are believed to have value in identifying the economic past condition.
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Question (Test 2)
1. Which of the following statement is most accurate, in short run, when inflation increases lower than expectation? A. GDP remains constant B. GDP increases above its full employment level C. GDP falls below its full employment level 2. Current unemployment rate, natural rate and inflation rate is equal to 5%, 5% and 3% respectively. Government is considering to increase aggregate demand through monetary measures. Given this situation, in short run, unemployment rate and inflation rate will.. This files has expired at 30-Jun-13 A. Unemployment will fall below 5% and inflation below 3% B. Unemployment will fall below 5% and inflation above 3% C. Unemployment will be above 5% and inflation above 3% 3. Which of the following statement best describes inflation? A. Rising price level of some goods B. Constant rise in price level C. Increasing purchasing power
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Question (Cont)
4. In cost-push inflation : A. GDP to initially decreases due to decrease in aggregate supply. B. GDP to initially increases due to decrease in aggregate supply. C. GDP to initially increases due to increase in aggregate supply. 5. The contraction phase of the business cycle is most likely to feature: A. Decreasing unemployment B. Increasing inflation pressure C. Declining economicThis output files has expired at 30-Jun-13
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Solutions
1. C. GDP falls below its full employment level when inflation is below expectations as AD increases less than expected and AS remain at expected level 2. B. Given negative relationship between inflation and unemployment in short run, unemployment will fall below natural rate and price level (inflation) increases 3. B. Inflation causes constant rise in price level for all goods and decreases purchasing power. 4. A. Cost push inflation initially decreases GDP due to decrease in aggregate supply. 5. C. An economic contraction is likely to feature increasing unemployment, declining economic output & decreasing inflationary pressure
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Questions
1. At potential real GDP, long-run aggregate supply is: A. horizontal
B. vertical C. increasing function of price level
2. Aggregate demand will increase with:

A. Fall in the expected level of inflation B. Decrease in income C. Decrease in countrys exchange rate
3.
This files has expired 30-Jun-13 Which one of the factor is least likely to impact aggregateat supply in long run
A. Changes in the quantity of capital B. Changes in the wage rate C. Changes in the technology
4.
A rise in money wage rate in short run is

A. Caused due to increase in inflation and decrease in unemployment and it causes shift in aggregate supply (AS) B. Caused due to decrease in inflation and increase in unemployment and it causes no change in AS C. Caused due to decrease in inflation and increase in unemployment and it causes shift in AS
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Questions (Cont)
5. Aggregate demand is equal to
A. Consumption + Investment + Govt. Spending +Imports - Exports B. Consumption + Investment + Govt. Spending -Imports + Exports C. Consumption + Investment Govt. Spending + Imports Exports
6.
Aggregate demand will

A. Increase as money supply increases and decrease as countrys exchange rate falls B. Increase as money supply increases and decrease as countrys exchange rate increase C. decrease as money supply increases and countrys exchange rate falls
7.
Thiswhen files has expired at 30-Jun-13 Recessionary gap occurs

A. There is a excess supply pushing downward pressure on price B. There is a excess demand pushing upward pressure on price C. Businesses experience unintended decrease in inventory
8.
Which of the following theories says that wage rate are downward sticky
A. Keynesian B. Monetarist C. Both Keynesian and Monetarist
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Solutions
1. B. The LRAS curve is vertical at the level of potential GDP. 2. C. Aggregate demand will increase with rise in expected level of inflation, increase in income & decrease in countrys exchange rate. 3. B. Wage rate affects supply only in short run where three factors - quantity of capital, labor and technology affects both in short and long run 4. A. Increase in unemployment rate and inflation expectations causes increase in resource prices (money wage rate) which leads to shift in SAS 5. B. Consumption + Investment + Govt. Spending + Net exports (Exports Imports) 6. B. Increasing money This supply will = Interest = C and I 30-Jun-13 = AD whereas increasing files hasrate expired at exchange rates will decrease exports as domestic goods become dearer to foreigners and increase imports causing net exports to decrease and hence AD to fall. 7. A. Recessionary gap occurs when there is a excess supply pushing downward pressure on price. Businesses will experience build of inventory and start reducing prices and production. 8. C. Both Keynesian and Monetarist believes that wage rates are downward sticky which reduces the ability of producer to increase supply
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Agenda
Aggregate Output, Prices, Economic Growth, Fiscal balance, Trade balance, Long run equilibrium and disequilibrium, Aggregate Demand curve Theories of business cycle and its phases, measurement of unemployment, Inflation, disinflation, Factors that affect price levels and Economic indicators. Monetary and Fiscal Policy
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Compare Monetary And Fiscal Policy

Monetary policy : It is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The main objective of monetary policy is relatively stable prices and low unemployment in the economy. It is referred to as either being expansionary or contractionary, where an expansionary policy increases the total supply of money in the economy more rapidly than usual, and contractionary policy expands the money supply more slowly than usual or even shrinks it. Expansionary policy is traditionally used to try to combat unemployment in a recession by lowering interest rates in the hope that easy credit will entice businesses into expanding. Contractionary policy is intended to slow inflation in hopes of avoiding the resulting distortions and deterioration of asset values. Monetary policy differs from fiscal policy, which refers to taxation, government spending, and associated borrowing.
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Compare Monetary And Fiscal Policy (Cont..)

Fiscal policy:
Fiscal policy is the use of government expenditure and revenue collection (taxation) to influence the economy The two main instruments of fiscal policy are government expenditure and taxation. Changes in the level and composition of taxation and government spending can impact the following variables in the economy:
- Aggregate demand and the level of economic activity; - The pattern of resource allocation; - The distribution of income.
The three possible stances of fiscal policy are neutral, expansionary and contractionary. The simplest definitions of these stances are as follows: A neutral stance of fiscal policy implies a balanced economy. This results in a large tax revenue. Government spending is fully funded by tax revenue and overall the budget outcome has a neutral effect on the level of economic activity. An expansionary stance of fiscal policy involves government spending exceeding tax revenue. A contractionary fiscal policy occurs when government spending is lower than tax revenue
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Functions Of Money
Functions of Money:
Medium of exchange - Accepted as payment for goods and services Used to store value - Saved money can be used later for future needs Unit of account - Used to express prices of goods and services
Measures of Money: M1 All currency except held at banks + travelers checks + checking a/c deposits of individuals and
firms M2 M1+ time deposits + saving deposit + money market mutual fund balances NOT counted as money:
Outstanding Checks since it just a transfer or medium of money from one owner to other instead of real
money Credit card transactions
Short term loan till the bill due date Does not increase money supply
Quantity Theory Of Money

Equation of exchange: Money supply (M) x Velocity (V) = GDP = Price (P) x Real Output (Y) (MV=PY) Velocity: Nominal GDP / Money Supply Represents average number of times each dollar is used to buy goods and services in an year Quantity theory of money (QTM) states that increase in money supply will cause a proportional increase in prices (inflation) since Velocity (V) and real output (Y) change very slowly This can be understood by rearranging equation of exchange where P = MV/Y Monetarists believe M should be increased only at the growth rate of real output (Y) so as to maintain price stability. In the long run the QTM will describe the results of money supply growth in excess of the growth rate of real output. If real GDP grows at 3% over time and the money supply is increasing at 5%, we can expect longrun inflation of 2% (5% - 3%).
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Creation Process Of Money

Fractional reserve banking system Based on Required Reserve Ratio banks reserve fraction of its deposits and loan the remaining amount Amount of loans a bank can generate with new deposits Amount of new deposit / reserve ratio Example: Suppose 10% of the deposit is to be reserved; $100 is the deposit. excess reserve = $90 which can be lent; Suppose the borrower spends it in certain things & the receiver deposits the entire money in the bank; now the bank can lend 0.90*90 = $81 Similarly in total, $100 of new deposit can increase money supply by $1,000 ($100 /0.10)
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Relation Between Monetary Base, Money Multiplier, And The Quantity Of Money
Monetary Base: Bank deposits , Money in circulation When the Fed uses open market operations to expand the monetary base, Quantity of money increases with a multiplier effect due to concept of reserve ratio Currency drain which is part of the increase in the money supply which people hold as currency instead of depositing Hence money multiplier, for a change in the monetary base, depends on both the required reserve ratio and the currency drain

1 c rc
Money Multiplier
where c is currency as a percentage of deposits (currency drain) r is the required reserve ratio The relation among the monetary base, the money multiplier, and the quantity of money can be stated as: Change in quantity of money = Change in Monetary Base x Money Multiplier
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Money Demand Curve

Downward slopping demand curve for money Vertical (perfectly inelastic) supply curve, i* = equilibrium interest rate Supply of money is determined by the central bank (Fed or RBI) which is independent of the interest rate.
Interest Rate Money Supply

The equilibrium interest rate i*, equates the demand & supply for money I*
Demand for Money
Real Money
Supply & Demand for Money
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Interest Rate Determination

The equilibrium interest rate (EIR), i*, is the interest rate where Demand to hold real money = real money supply If interest rates are higher than EIR, there is excess supply which causes purchase of securities => reduces supply => reduces interest rates to EIR Vice versa occurs when interest rates are lower than EIR
Interest Rate Money Supply

At ihigh, there is excess supply of money, leading to purchases of securities Ihigh I* ilow Demand for Money At ilow, there is excess demand of money, leading to sells of securities
Real Money
Disequilibrium in Money Market

Types Of Depository Institutions

Commercial banks Accept deposits from savers and loan to borrowers Deal in short term securities (treasury bills): Investment in long terms securities (treasury and corporate bonds) Under fractional reserve banking system, banks are required to deposit a portion of deposits either with Reserve Bank or/and keep a specific portion in cash/secured securities Thrifts and thrift institutions:
This files has expired at accounts, 30-Jun-13 Saving & loan associations (S&L) both checking and saving issue all kinds of loans
Saving banks only saving accounts, issue primarily home loans Credit unions for specific group of individuals Money market mutual funds: Manages pooled funds invested in short term debt (<1 yr maturity) Securities to preserve the funds value and get returns Investment management firm
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Goal Of Central Bank

Manage the money supply with a perfect balance to have low inflation & promote economic growth Three tools available to attain such goals: Bank Rate: (discount rate): Rate of interest which a central bank charges on the loans and advances to commercial banks and other financial intermediaries Cash Reserve: % of deposits that banks retain in cash or deposit with Fed Open Market Operations: Fed buy or sell treasury securities in open market Fed's most commonly used tool to achieve the federal funds target rate
Broadly there are following 4 economic functions of depository institutions Acting as Financial Intermediaries Provide Liquidity Risk Monitoring Pooling of Individual Risks
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How Central Banks Influence Interest Rates

If Central Bank wants to decrease short-term interest rates
Buy securities in the open market => increases the real money supply and bank reserves => further increase in the real money due to multiplier impact => shifts real money supply curve to right Excess supply of money balances decreases interest rates
Interest Rate MS0 MS1
If Central Bank wants to increase interest
,sell securities in the open market This files has expired at rates 30-Jun-13
5% 4%
Demand for Money
Real Money
Increase in money supply decrease the interest rates
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Effect Of Increase In Money Supply At Full Employment GDP

Interest Rate MS0 MS1 LAS Price Level SAS1
SAS0 (SR) P2 P1 P0 AD1
5% 4% (SR) Demand for Money
AD0
(LR)

Real Money Real GDP
Increase in Money Supply
Resulting increase in aggregate demand
Increase in AD increases real GDP > full-employment GDP,

Cost of money and other productive resources will rise which Causes SAS shift to move upward and intersects demand curve at full employment GDP level (LAS) hence GDP returns to full employment GDP. Hence there is only a temporary increase in GDP
But price level (rate of inflation) increases and move upward to LAS
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Financial Regulation, Deregulation And Innovation

Impact of financial regulations: Cash reserves: Institutions needs to retain a minimum percentage of deposits (depends on accounts) as cash or deposit with central bank. Proportion of various types of loans Institutions have restrictions on various types of loans (depends on institutions) Types of deposits Institutions have restriction on different types of deposits (ex: saving, checking).
This has expired at 30-Jun-13 Share of owners capital files A minimum amount should be maintained as institution owners capital
(equity) so that owner manages the risk of the asset portfolio better.
Impact of Bank-deregulation: High competition between banks and thrifts & low barriers to entry to other
institution to compete with banks
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Financial Regulation, Deregulation And Innovation

Financial innovations: New financial products (e.g. : Variable mortgages and S&Ls, New type of accounts , Technology innovations (computerization, internet, ATM) Impact of Financial innovations: Declining savings account deposit caused money market mutual fund to grow substantially Checking account deposits shifted from banks to thrifts & cost of transactions reduced significantly Monetary policy refers to attempts by a central bank to :
Influence inflation and the growth rate of the economy Through changes in the money supply and interest rates. Federal Reserves (Fed) Goals :
To maintain price level stability

Keeping stable inflation rate between 0% and 3%. Maximize potential GDP and the growth rate of GDP
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Overview Of Central Bank (Other Than US)

Functions of Central Bank (other than US): Manage money supply to keep prices stable, achieve maximum sustainable real GDP Issue currencies Regulate banking system
Tool available with Central Bank (other than US) Discount rate knows as
Repo or repurchase rate in UK Cash rate in Australia Reserve requirement Open market transactions Buying and selling of securities
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Monetary Policies Strategies And Drawbacks

Friedman rule suggests to increase money supply at the rate which potential real GDP grows Ignores velocity of money and demand for money; both of which can lead to changes in interest rates and aggregate demand McCallum rule sets the money supply growth rate equal to the target inflation rate plus the long term real GDP growth (10-year moving average) rate minus velocity growth rate (4-year moving average). Focuses only on money supply and ignores changes in demand for money which causes changes in
files has expired interest rates leadingThis to changes in aggregate demand

stable with basket of currencies / currency
at 30-Jun-13
Stable exchange rate suggests to increase money supply at the rate which keeps country exchange rate
It causes to adopt another countrys inflation rate in long run which government cannot control
Inflation targeting (Taylor rule) as explained in previous slides

US does not target inflation rather focuses on full employment at stable price
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Fiscal Policy
Fiscal policy refers to:
Government use of spending and Taxation
Government uses fiscal policies to manage overall GDP growth.

Taxes are increased and/or government spending reduced during inflationary periods, Taxes are decreased and/or government spending increased during recessionary periods
Budget surplus occurs when government tax revenues > expenditures Budget deficit occurs when government expenditures > tax revenues
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Generational Effects Of Fiscal Policy

Generational Accounting Measures the lifetime tax burden and social security benefits of each generation People pay taxes while working to receive social security benefits when they retire by govt. Difference between taxes paid and benefits received causes fiscal imbalances measured as Present value of benefits to be paid less present value of taxes to be received by government To fund fiscal imbalance, govt. can raise income and social security taxes or reduce spending

Generational Imbalance It divides Fiscal imbalance between current generation and future generation Helps deciding who will and how much one will pay
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Fiscal Policy To Stabilize Economy

Stabilize of economy through fiscal policy can be automatic (government does nothing and state of economy decides future course of action ) and discretionary
Discretionary fiscal policy: Government changes tax rates and spending with the intention to stabilize the economy If government spending is increased it causes AD to increases by a multiplier amount, generating
This files has expired 30-Jun-13 additional income which leads to increases in C and I which at in turn further increases AD and incomes
If taxes are reduced, people consume more which fuels up AD and this in turn increases income and consumption in turn this cycle repeats but weakened by amount of tax cuts which is saved Hence both government spending and tax cuts increases AD thereby increasing GDP but multiplier
impact of tax cut is smaller than the govt. spending
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Fiscal Policy To Stabilize Economy (Cont..)

Recessions: Increase government spending and/or decrease taxes, strengthen the economy by increasing AD
Inflationary economic expansions: Decrease government spending / increase taxes (decreasing AD)
When both government spending is increased and taxes are increased then since multiplier impact of government spending is higher than multiplier impact of tax cuts, AD grows only by balance multiplier impact (government spending multiplier tax rates multiplier)
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Supply-side Effects
Fiscal policy measures such as changes in tax rates affects long run aggregate supply (AS)- Such effects are known as supply-side effects
Income taxes:
Increase in income taxes decreases after tax salary to workers which leads to: (As explained in next slide) Reduction in number of hours deployed by workers => supply to fall
Reduces potential This GDP
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Consumer expenditures tax (Sales Tax / VAT etc.) A rise in such taxes decreases the amount of goods that each hour of labor can buy which leads to Same supply side effects like increase in income tax
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Effect Of Taxes
Wages
SAT
Real GDP
Production Function
SBT
QBT QAT

D Labor LAT LBT LAT Taxes & Potential GDP LBT Labor
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Laffer Curve
Given the relationship between Taxes (up), supply - production hours (down) and GDP (fall), Economist Arthur Laffer concludes that an increase in tax rates will not always increases tax revenue.
Tax Revenue
At a 0% tax rate, potential GDP is maximized 0 taxes are collected.
At a 100% tax rate, tax revenue is 0 as no

one is willing to supply labor
Tax rate 0% 100% Laffer Curve tm
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Limitations Of Discretionary Fiscal Policy

Incorrect actions by incorrectly predicting economic forecast
Recognition delay: It takes time to recognize the current state of the economy and extent of the economic problems which delays to adopt right measures through discretionary policy
This files expired at 30-Jun-13of policy measures Administrative or law-making delayhas in acceptance and implementation
Impact delay: Effects of the fiscal policy changes takes time to improve state of economy
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Automatic Stabilizers
Automatic stabilizers are built-in fiscal devices based on state of the economy Minimize timing problems as faced by discretionary fiscal policy stabilizers Two main categories:
Induced taxes: amount of taxes collected as a percentage (i.e., income tax rate) of income. Incomes are positively related to GDP. Needs-tested spending: Government expenditures for programs that pass a "needs" test, such as unemployment. During recession, unemployment is high. The govt. pays out more in unemployment compensation. But both actions are countercyclical: taxes rise and needs-based spending falls during expansions, and taxes fall and needs-based spending rises during recessions.
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Whether A Fiscal Policy Is Expansionary Or Contractionary

A government has a budget surplus when tax revenue exceed government spending and a deficit when spending exceeds tax revenue An increase (decrease) in a government budget surplus in indicative of a contractionary (expansionary) fiscal policy. Similarly, an increase (decrease) in a government budget deficit is indicative of an expansionary (contractionary) fiscal policy.
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Impact Of Fiscal Policy On Capital Markets

Fiscal policy also affects the supply of government savings Larger budget deficits require government to borrow and decreases quantity of savings, which increases the real interest rate, causing firms to reduce borrowing of financial capital and investment in physical capital
Crowding out effect: Government borrowings crowd out more productive private borrowings due to
This deficit files has expired at higher interest rate. Budget reduces private investments.
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Such decrease in the growth rate of capital will reduce potential GDP
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Impact Of Fiscal Policy On Capital Markets (Cont)

However, Ricardo Barro effects says that fiscal deficit does not have any crowding out effect because Current fiscal deficits will be funded by higher taxes in future which Causes people to save more today to keep their consumption same and People invests such savings in govt. bonds issued to fund deficits Hence deficit does not reduces savings and does not have crowding effect
Taxes on capital income affect the quantity of savings and investment
As taxes on capital income rise, private savings likely will fall as post tax return on savings fall
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Interaction Of Monetary And Fiscal Policy

The monetary and Fiscal policy may each other can be expansionary or contractionary, so their are four possible scenario:
Expansionary Fiscal and Monetary Policy Contractionary fiscal and Monetary Policy Expansionary fiscal policy + Contractionary monetary policy

Contractionary fiscal Policy + Expansionary monetary policy
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Question
1. What is the maximum increase in the money supply on Fed decision if (a) Fed buys $2billion in securities in the open market (b)required reserve ratio is 10% and (c)Currency drain is 2%: A. $20 billion B. $17 billion C. $16 billion The velocity of circulation is most likely the A. Number of times money is used B. Speed with which quantity of money increases This files has expired at 30-Jun-13 C. Shifts in the Money supply curve when the quantity of money changes
2.
3. The Fed wants to increase the growth of the economy. The least appropriate action will be A. Purchase government securities B. Lower discount rates C. Increase the reserve requirement 4. Central bank reduces money supply: A. By increasing bank rates and buying securities in open market B. By increasing bank rates and selling securities in open market. C. By decreasing bank rates and buying securities in open market
Question (Cont)
5. Demand curve of money is downward slopping because. A. At low interest rates, firms and individuals hold more money due to low opportunity cost of holding money. B. At low interest rates, firms and individuals hold more money due to high opportunity cost of holding money C. At high interest rates, firms and individuals hold less money due to low opportunity cost of holding money
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Solutions
1. B. 17; Change in quantity of money = Change in monetary base x money multiplier; Money Multiplier = (1+ c) /(r + c)= (1.02)/(.12)= 8.5; 2 X 8.5 =17 A. The velocity of circulation is the number of times the money circulates in the market annually. C. Increasing the reserve rates reduces the amount that can be lent to borrowers. B. Central bank reduces money supply by increasing bank rates and selling securities in open market (suck out cash from the market and reduces supply) A. Demand curve of money is downward slopping because at low interest rates, firms and individuals hold more money and invest less due to low opportunity cost of holding money.
2.
3. 4.
5.
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Questions From Chapter (17, 18, 19)

1. Which of the following statement is most accurate on crowding out effect? A. Fiscal deficit increases government spending and private investments B. Fiscal deficit does not have impact on interest rates C. Private borrowing reduces during budget deficit 2. When government increases spending and taxes, aggregate demand will: A. Not change as increase in AD caused by spending is offset by decrease in AD caused by high taxes B. Increase by balance multiplier impact C. Decrease by balanceThis multiplier impact has expired at 30-Jun-13 files 3. Generational fiscal imbalance is equal to: A. Savings less investments B. PV of benefits to be paid less PV of taxes to be received C. Government expenditures minus government revenues
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Question
4. Calculate change in FFR given: Target inflation rate= 2%; actual inflation rate=3%, actual GDP growth rate = 3%; Potential GDP = 3.5% ; Current FFR = 5%; A. 5.25% B. B. 5.5% C.C. 0.25% 5. Which of the following statement best describes Feds objective? A. Reduce inflation rates to zero files level This has expired at B. Maintain price stability and maximize current GDP C. Maintain price stability and maximize potential GDP In case of positive output GAP: A. Inflationary gap occurs and Fed decreases money supply B. Recessionary gap occurs and Fed increases money supply C. Recessionary gap occurs and Fed decreases money supply
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6.
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Solutions
1. C. During budget deficits, government borrows more to fund the deficit such borrowings crowd out more productive private borrowings due to higher interest rate hence private investments falls. 2. B. Since multiplier impact of govt spending is higher than multiple impact of changes in tax rates, AD increases only by balance multiplier impact. 3. B. Fiscal imbalance is equal to difference between taxes paid and benefits received and measured as present value of benefits to be paid less present value of taxes to be received by government

4. C. New FFR =target inflation rate (TI) + actual inflation (AI) + 0.5 (AI - TI) + 0.5 (o/p GAP) New FFR = 2% + 3% + 0.5 (3%- 2%)+ 0.5 (3%-3.5%) = 5.25% Change in FFR = 5.25 5 = 0.25%
5. C. The Feds primary objective is to maintain price stability (keep inflation between 0 and 3%) and maximize long-run economic growth (potential GDP).
6. A. When output gap is positive (actual > potential GDP), inflationary pressures exist and Fed reduces money supply.
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Five Minute Recap

Potential GDP aggregate hours worked Labor productivity Potiential GDP growth in labor force growth in labor productivity
Renewable sources are replenished by nature. E.g. Water Non Renewable is either not replenished or at very slow rate. E.g. Oil
Unemployment Rate : [(number of employed) / (labor force)] * 100 Labor force participation rate = [(labor force) / (working population)] * 100 Employment-to-population ratio = [(no. of employed) / (working population)] * 100
Money Multiplier
Y = C + I + G + NX This files has expired at 30-Jun-13 1 c
Economic Indicator categories: Leading Indicator Co-incidence Indicators Lagging indicators
rc
Relationship between GDP and Unemployment If real GDP < potential GDP cyclical unemployment . If real GDP > potential GDP cyclical unemployment
CPI
Cost of basket at current prices 100 Cost of basket at base period price
GDP Deflator:
Value of Current year GDP at current year prices 100 Value of Current year GDP at base year prices
Types Of Unemployment Cyclical unemployment Frictional unemployment Structural unemployment
Growth in Potential GDP = Growth in technology + Growth in Labor + Growth in Capital
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Five Minute Recap

Limitations Of Discretionary Fiscal Policy: Incorrect actions Recognition delay: Admin or law-making delay Impact delay Tools for Central Bank Bank Rate Cash Reserve: Open Market Operations Functions of Money: Medium of exchange Used to store value Unit of account Categories of Automatic Stabilizers: Induced taxes Needs-tested spending Goal Of Central Bank Manage the money supply Balance to have low inflation Promote economic growth
Fiscal policy refers to: Government use of Spending and Taxation
This Economic functions of Depository institutions Acting as Financial Intermediaries Provide Liquidity Risk Monitoring Pooling of Individual Risks
files has expired at 30-Jun-13 SRAS 2 Price Level

LRAS SRAS1 Price Level LRAS
SRAS2 SRAS1
P3 P2 P1 AD2 AD1 P3 P2 P1 AD2 AD1
Mainstream Business Cycle Theory: If growth in AD > Potential Real GDP growth = Inflationary Gap If growth in AD < Potential Real GDP growth = Recessionary Gap
GDP1 GDP2
Demand Pull Inflation

Neev Knowledge Management Pristine 87
Real GDP
GDP2 GDP1
Real GDP
Cost Pull Inflation

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CFA 1 Economics-II

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GDP Using Income And Expenditure Methods

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Govt Savings (surplus) = Tax revenue government expenditure

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GDP, National Income, Personal Income And Personal Disposable Income

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Nominal And Real GDP, Calculate GDP Deflator

(price of good i in current year) (quantity of good i produced in current year)

(price of good i in base year) (quantity of goods i produced in current year)

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GDP, National Income, Personal Income And Personal Disposable Income

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(G-T) = (S-I) (X-M)

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This files has lower expired at 30-Jun-13 LM curve, M/P

LM curve, higher M/P (lower P)

IS Curve Real income

External Economies/ Diseconomies Of Scale

External Diseconomies of scale

Why LAS Is Vertical Line While SAS Is Upward Sloping

The level of real GDP on the LAS curve is the

economy's level of production when the economy is

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As the amount of available capital in the economy

changes, or As technology improves the productivity of capital, labor, or both

Aggregate supply in Long run and Short run

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Components Of Aggregate Demand

Here, there are two effects:

Three factors shifting the aggregate demand curve:

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Factors That Influence The Demand Of Capital

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Factors That Influence The Supply Of Capital

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move the economy to long-run macroeconomic equilibrium

An Increase in Potential GDP

Equilibrium is at a price level of 110

Real GDP GDP1

Adjustment To An Increase In Aggregate Demand (AD)

The increase in the price level (from P0 to PSR ) at

new equilibrium level means that workers' real wages

Increase in demand will cause businesses to attempt

Adjustment to an increase in aggregate demand

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Adjustment To A Decrease In Aggregate Demand

Resulting excess supply of labor (workers

seeking jobs) will put downward pressure on

Real O/P GDP GDP1 GDP*

Adjustment to a decrease in aggregate demand

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