Economic Fluctuations and Aggregate Demand

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Economic Fluctuations and Aggregate Demand
ECO 105 Lecture 4.3 20 April 2007
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Quick Review of AD Curve

• Looks like an ordinary demand curve but looks
  are deceiving.
• Slopes negatively due to
• Wealth effect real asset values
• Interest-rate effect cost of borrowing
• Exchange-rate effect Imports cost more
• These combine to yield a negatively sloped AD
  curve.

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Aggregate Demand
Were still reviewing!

• Y C I G NX
• Y is real GDP, so the components of aggregate
  demand are in real terms.
• I.e., measured in base-year prices.

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Shifting the AD Curve
New stuff!

• Americans save more
• Businesses invest more
• An increase in income-tax rates reduces
  consumption spending
• The Fed increases the money supply . . .
• Foreign economies expand . . .

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The Expenditures Multiplier

• When I, G, or NX rises, Y ____________.
• Consumption depends on disposable income C C
  (Y T )
• Thus, when a change in exogenous spending causes
  Y to increase, an _______________ increase in C
  follows.
• So, ?Y ?I ____.

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The Expenditures Multiplier

• The increase in C further increases Y, which
  causes C to _____ _____ _____.
• Consumption could rise by _________ times the
  amount of initial ?I.
• Ultimately, ?Y ?I ?C1 ?C2

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How big is the expenditures multiplier?

• Like the money multiplier, in theory it could
  be________ (e.g., 10).
• In reality, several factors (income taxes,
  saving, imports) constrain the multiplier to a
  relatively ______ number probably 1.5 to 2.5.
• So, e.g., ?Y 1.5 x ?I.

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Long-Run Aggregate Supply

• Weve already done the work.
• Y A.F (L, K, H)
• Does PI appear anywhere in the equation?
• ____!
• Then the long-run AS curve is ________.

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LRAS Curve
PI
Because the price level is not related to
production over long periods of time, the LRAS
curve is vertical.
RGDP
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Completing the Model

• AD and LRAS together
• Shift in AD changes only the _____ _____
• Does this mean that all fluctuations in Y are
  caused by fluctuations in the production
  function?
• Most economists _____ _______ ____.
• Back to the drawing board!

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Bonus Quiz Time!!!