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Unit 3:

Aggregate Demand and


Supply and Fiscal Policy

Shifters of Aggregate Demand


AD = C + I + G + X
Change in Consumer Spending

Change in Government Spending


Change in Investment Spending
Net EXport Spending

Shifters of Aggregate Supply


AS = I + R + A + P
Change in
Change in
Change in
Change in

Inflationary Expectations
Resource Prices
Actions of the Government
Productivity (Investment)
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Practice

Answer and identify shifter: C.I.G.X or

R.A.P

B
A
D
A
D
B
A
A
C
A

A major increase in productivity.


4

Putting AD and AS together to get


Equilibrium Price Level and Output

Inflationary and
Recessionary Gaps

Example: Assume the government increases


spending. What happens to PL and Output?
Price
Level

LRAS
AS

PL and Q will
Increase

PL1
PLe

AD
QY Q1

AD1

GDPR

Inflationary Gap
Output is high and unemployment is less than NRU
LRAS
Price
Level

AS

Actual GDP
above potential
GDP

PL1

AD1
QY Q1

GDPR

Example: Assume the price of oil increases


drastically. What happens to PL and Output?
Price
Level

LRAS

AS1

AS

PL1

Stagflation

PLe

Stagnate Economy
+ Inflation
AD
Q1 QY

GDPR

Recessionary Gap
Output low and unemployment is more than NRU
LRAS AS1
Price
Level

Actual GDP
below potential
GDP

PL1

AD
Q1 QY

GDPR

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AD and AS Practice
Worksheet

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How does this cartoon relate to Aggregate Demand?

12

Draw AD and AS at full employment


Price Level

LRAS
AS

P2
P1

AD2
AD=C+I+G+X
Qf Q2
(Y*or FE)
Output Increases

GDPR

PL Increases
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Short Run and


Long Run

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Shifts in AD or AS change the price level and


output in the short run
Price
Level

LRAS
AS

PLe

AD
QY

GDPR

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Example: Assume consumers increase


spending. What happens to PL and Output?
Price
Level

LRAS
AS

PL1
PLe

AD
QY Q1

AD1

GDPR

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Now, what will happen in the LONG RUN?


Inflation means workers seek higher wages and
production costs increase
LRAS AS1
Price
Level

AS

PL2

Back to full
employment with
higher price level

PL1
PLe

AD
QY Q1

AD1

GDPR

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Example: Consumer expectations fall and


consumer spending plummets. What happens to
PL and Output in the Short Run and Long Run?
Price
Level

LRAS

AS
AS1
AS increases as
workers accept lower
wages and production
costs fall

PLe
PL1
PL2

AD1
Q1 QY

AD
GDPR

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