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Macro-C33 Ad As Model
Macro-C33 Ad As Model
Macro-C33 Ad As Model
Based on
Principles of Economics (5ed)
N. Gregory Mankiw
Original Slides by
Ron Cronovich
8,000
0
1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
4
Three Facts About Economic Fluctuations
FACT 2: Most macroeconomic
quantities fluctuate together.
2,500
Investment spending,
2,000
billions of 2000 dollars
1,500
1,000
500
0
1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
5
Three Facts About Economic Fluctuations
FACT 3: As output falls,
unemployment rises.
12
10 Unemployment rate,
percent of labor force
8
0
1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
6
Introduction, continued
Explaining these fluctuations is difficult, and the
theory of economic fluctuations is controversial.
Most economists use the model of
aggregate demand and aggregate supply
to study fluctuations.
This model differs from the classical economic
theories economists use to explain the long run.
“Short-Run
The model P1 Aggregate
determines the Supply”
eq’m price level “Aggregate
Demand” AD
Y = C + I + G + NX P
Assume G fixed
P2
by govt policy.
To understand
the slope of AD,
P1
must determine
how a change in P AD
affects C, I, and NX. Y
Y2 Y1
Example: P1
A stock market boom
makes households feel
AD2
wealthier, C rises,
AD1
the AD curve shifts right.
Y
Y1 Y2
20
ACTIVE LEARNING 1
Answers
A. A ten-year-old investment tax credit expires.
I falls, AD curve shifts left.
B. The U.S. exchange rate falls.
NX rises, AD curve shifts right.
C. A fall in prices increases the real value of
consumers’ wealth.
Move down along AD curve (wealth-effect).
D. State governments replace sales taxes with new
taxes on interest, dividends, and capital gains.
C rises, AD shifts right.
21
The Aggregate-Supply (AS) Curves
The AS curve shows P LRAS
the total quantity of
g&s firms produce SRAS
and sell at any given
price level.
AS is:
upward-sloping
in short run
Y
vertical in
long run
Y = YN + a (P – PE)
Output Expected
price level
Natural rate
of output
a > 0,
measures Actual
(long-run) price level
how much Y
responds to
unexpected
changes in P
SRAS
When P > PE
the expected
PE
price level
When P < PE
Y
YN
Y < YN Y > YN
AGGREGATE DEMAND AND AGGREGATE SUPPLY 38
SRAS and LRAS
The imperfections in these theories are
temporary. Over time,
sticky wages and prices become flexible
misperceptions are corrected
In the LR,
PE = P
AS curve is vertical
P LRAS
SRAS
In the long run,
PE = P
PE
and
Y = YN.
Y
YN
AGGREGATE DEMAND AND AGGREGATE SUPPLY 40
Why the SRAS Curve Might Shift
Everything that shifts
LRAS shifts SRAS, too.
P LRAS
Also, PE shifts SRAS: SRAS
SRAS
If PE rises,
PE
workers & firms set
higher wages.
PE
At each P,
production is less
profitable, Y falls,
Y
SRAS shifts left. YN
1933
1934
1929
1930
1931
1932
from 3% to 25%
AGGREGATE DEMAND AND AGGREGATE SUPPLY 45
Two Big AD Shifts:
2. The World War II Boom
U.S. Real GDP,
From 1939-1944, billions of 2000 dollars
govt outlays rose 2,000
1940
1942
1939
1941
1943
1944
AGGREGATE DEMAND AND AGGREGATE SUPPLY 46
ACTIVE LEARNING 2
Working with the model
Draw the AD-SRAS-LRAS diagram
for the U.S. economy
starting in a long-run equilibrium.
A boom occurs in Canada.
Use your diagram to determine
the SR and LR effects on U.S. GDP,
the price level, and unemployment.
47
ACTIVE LEARNING 2
Answers
Event: Boom in Canada P LRAS
1. Affects NX, AD curve SRAS2
2. Shifts AD right
3. SR eq’m at point B. P3 C SRAS1
P and Y higher, P2 B
unemp lower
P1 A AD2
4. Over time, PE rises,
SRAS shifts left, AD1
until LR eq’m at C. Y
YN Y2
Y and unemp back
at initial levels. 48
The Effects of a Shift in SRAS
Event: Oil prices rise
1. Increases costs, P LRAS
shifts SRAS
SRAS2
(assume LRAS constant)
2. SRAS shifts left SRAS1
B
3. SR eq’m at point B. P2
P higher, Y lower,
P1 A
unemp higher
From A to B,
stagflation, AD1
a period of Y
Y2 YN
falling output
and rising prices.
AGGREGATE DEMAND AND AGGREGATE SUPPLY 49
Accommodating an Adverse Shift in SRAS
If policymakers do nothing,
4. Low employment P LRAS
causes wages to fall, SRAS2
SRAS shifts right,
until LR eq’m at A. P3 C SRAS1
B
Or, policymakers P2
could use fiscal or P1 A
monetary policy to AD2
increase AD and
AD1
accommodate the AS
Y
shift: Y2 YN
Y back to YN, but
P permanently higher.
AGGREGATE DEMAND AND AGGREGATE SUPPLY 50
The 1970s Oil Shocks and Their Effects
1973-75 1978-80
58