Exploration 13

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Exploration 13

• Macroeconomic AD/AS Model
• AD Aggregate Demand
• AS Aggregate Supply

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Thread

• So far we have investigated the nature of
  capitalism, and various measurements indicating
  the state of the economy.
• Now we turn to explaining WHY the economy might
  be in good or bad shape.
• Its as easy as looking at demand.

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You should be able to

• Explain why models are important analytical tools
  for understanding the economy
• Explain the demand side of the policy model AD
  curve its shape and shifters
• Use the multiplier and explain its importance

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Why are models necessary?

• Draw an airplane
• Essentials vs. non-essentials
• Economic knowledge (like all) is conjecture
• Many different ways to look at the world
• Models are a way of thinking about the world
• Much of our knowledge about the economy is
  embodied in models
• Models simplified representations of
  relationships within an economy

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Simple market model

• Consumers ? buy ? DEMAND
• Demanders respond to changes in price
• Price DOWN ? Quantity demanded UP
• Example Portable computers
• Motivation to maximize satisfaction (utility)
• Corporations ? sell ? SUPPLY
• Suppliers respond to changes in demand
• Demand stronger ? Quantity supplied more
• Example Hybrid cars (electric gas)
• Motivation to maximize profits
• If prices go UP, all the better to supply MORE

Further explanation of demand, supply and
equilibrium http//www.investopedia.com/universi
ty/economics/economics3.asp
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Derivation of Demand Curve
Price 9 8 7 6 5 4 3 2 1
Qn 5 10 15 20 25 30 35 40 45
As price falls ? movement along demand from point
A to B
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Supply Curve
Supply
4
Demand
45
Simple idea costs are fixed as production
expands or contracts
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Simple market model, expanded

• Consumers ? buy ? DEMAND
• Demanders respond to changes in price
• Price DOWN ? Quantity demanded UP
• Movement along the demand curve rule 1
• Demanders also respond to other changes
• Change in tastes (e.g. advertising) or income
• Shift of the demand curve rule 2

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Shifts in the Demand Curve
Price 9 8 7 6 5 4 3 2 1
Qn Demand Before Ads 5 10 15 20 25 30 35 40 45
Qn Demand After Ads 10 15 20 25 30 35 40 45 50
Supply
4
Demandafter
Demandbefore
45
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What is the impact of advertising?

• Demand shifts outward

Advertising plays on changing peoples tastes.
At a GIVEN price, people demand more
P
A
9.00
B
C
Supply
5.00
Demand2 after advertising
Demand1 before superbowl advertising
Qn
40
10
20
Note shift from B to C
Equilibrium2
Equilibrium1
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End of digression -- Summary

• If price changes ? movement along the demand
  curve Rule 1
• If anything other than price changes (like
  tastes) ? shift of the demand curve Rule 2
• Next no fault quiz

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AD/AS Model -- basic idea

• Purpose to understanding how much will be
  produced
• That is, whether we will employ our available
  resources fully, or if there will be unemployment
  (labor capital)
• Alternatively, if we will experience inflation
  due to over-using our resources when demand is
  excessive

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AD/AS Model -- key element

• The key to determining the level of output is
  aggregate demand
• Aggregate demand AD is the demand for all final
  goods and services in the economy.
• Sound familiar?
• AD is identical to GDP (real)
• C I G X M

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AD Curve Fig 9-1, p212

• Change price level ? change aggregate
  expenditures ? change real output (Y)
• Price level price index like CPI
• Aggregate expenditures GDP CIG (X-M)
• Real output quantity
• AD curve is downward sloping
• As CPI ? ? Expenditures up?

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The Aggregate Demand Curve
Figure 9-1
back
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Shifts in the AD curve

• Principle is what you already know
• Change in price ? movement along AD
• Change in anything else ? shift of AD
• The key shifters are those that affect the
  components of aggregate expenditures
• C I G X M

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What affects these components?

• Consumption
• Income, distribution of income, interest rates
• Investment
• Profit expectations, interest rates monetary
  policy
• Government expenditures
• Fiscal policy including taxes
• Net exports
• Foreign income, exchange rates

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Working with Aggregate Demand

• Team Exercise 13

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The multiplier

• A change in any component of aggregate
  expenditures (C I G X-M) SHIFTS the AD
  curve by MORE than the initial change
• If G? 50B ? Y (real output) ? 100B
• Why?
• Feedback or ripple effect
• Significance contributes to instability

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Multiplier, cont

• Change in output (?Y) multiplier (m) times
  initial change of any component of AD (?C, ?I,
  ?G, etc)
• If investment increases by 100B
• ?Y m?I
• ?Y 3(100B) 300B
• Figure 9-2, page 216
• Rule of thumb 12 month multiplier 2

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Effect of a Shift Factor on the AD Curve
Figure 9-2
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Wrap up What did you learn?

• What are models and why are they important
  analytical tools for understanding the economy?
• What is AD? What shifts it?
• What is the multiplier? Why is it important?