Aggregate Supply & Aggregate Demand

Aggregate Supply & Aggregate Demand

NOT Supply & Demand

Aggregate = Total national output (GDP)

Two time frames

Aggregate Supply & Aggregate DemandThe Long-run is a time frame when all adjustments to the economy are complete.

The Long-run is a time frame when all expectations about economic conditions are met.

The Long-run is a time frame when input and output prices adjust together.

The Long-run is a time frame when Actual Real GDP equals Potential Real GDP.

The Long-run is a time frame when unemployment is at the natural rate. (e.g. no cyclical unemployment)

Aggregate Supply & Aggregate DemandThe Short-run is a time frame when all adjustments to the economy are NOT complete.

The Short-run is a time frame when expectations about economic conditions are NOT met.

The Short-run is a time frame when input and output prices DO NOT adjust together.

The Short-run is when Actual Real GDP DOES NOT equal Potential Real GDP.

The Short-run is when unemployment differs from the natural rate. (cyclical unemployment exists)


BLUE = Long Run

(Growth Trend)

GREEN = Short Run


The Long-run Aggregate Supply Curve is the relationship between the Aggregate Quantity of Real GDP Supplied in the Long-run and the Average Price Level.

LRAS

100


The Long-run Aggregate Supply Curve is synonymous with the Production Possibilities Frontier


The Long-run Aggregate Supply Curve is synonymous with the Full Employment level of Real GDP


The Long-run Aggregate Supply Curve is synonymous with Potential Real GDP

The Long Run growth trend is the Long Run Aggregate Supply Curve (LRAS)


So: LRAS = PPF = Full Employment Real GDP = Potential Real GDP = The Economy’s Growth Trend


The Short-run Aggregate Supply Curve is the relationship between the Aggregate Quantity of Real GDP Supplied in the Short-run and the Average Price Level.


The Short-run Aggregate Supply Curve synonymous with Actual Real GDP


Aggregate Supply & Aggregate DemandBLUE = Long Run(Growth Trend)

A

D

B

GREEN = Short Run

A

B

D


Aggregate Demand is generated from Aggregate Expenditure: the total expenditure in the economy, or the sum of all spending:Consumption (households)Investment (business)GovernmenteXports (spending by R.O.W)iMports (spending on R.O.W)

AD = AE = C+I+G+(X-M)


The Aggregate Demand Curve is the relationship between the Aggregate Quantity of Real GDP Demanded and the Average Price Level.


Aggregate Supply & Aggregate DemandANYTIME there is a change in the Average Price Level (as determined by the CPI) there is movement along either the LRAS, the SRAS, or the AD curves.

ANYTHING other than a change in the Average Price Level will SHIFT the AS or the AD curves.

ANYTHING other than a change in the Average Price Level will SHIFT the AS or the AD curves.



AA

1) Point A = Full Employment Macro Long-Run Equilibrium

A


AB


2) Point B = Decrease in business Investment = drop in Aggregate Demand

How does the economy get back to full employment?

Laissez-faire

AB


AB

C


2) Point B = Decrease in business Investment = drop in Aggregate Demand

Laissez-faire = No unemployment; no welfare; no Social Security; No FED

3) Point C = high unemployment + no income = resource owners lower input prices

AB

C


C

C

C

1) Point C = Full Employment Macro Long-Run Equilibrium


C

D

C

D


2) Point D = Increase in business Investment = increase in Aggregate Demand


Laissez-faire


C

C

D

E

CD

E


2) Point D = Increase in business Investment = increase in Aggregate Demand


3) Point E = high inflation + no income = resource owners raise input prices


AA A



AB A

B


2) Point B = Increase in resource prices (oil, wages) = decrease in Aggregate Supply


Laissez-faire


AB

CCAC

B


2) Point B = Increase in resource prices (oil, wages) = decrease in Aggregate Supply


3) Point C = high unemployment + no income = resource owners lower input prices

Aggregate Supply & Aggregate DemandThe Great Depression

1) Everything you know about the Great Depression is wrong.2) You can’t see the forest for the trees.3) The Great Depression is a failure of capitalism.4) The Great Depression was caused by the 1929 stock market crash.5) The government got us out of the depression.6) WWII got us out of the Great Depression.

The Great Depression

$103b

1) 1913: 16th amendment to the U.S. Constitution2) 1913: Federal Reserve Act3) 1917 – 18: World War I (FED learns how to manipulate interest rates)3) 1917 – 18: World War I (Congress learns power of fiscal policy)4) 1920 – 21: Recession5) 1921 – 29: Roaring Twenties (FED keeps interest rates low)

AD1

122

A A

A

B

B

B

Sept. 1929: “There is no cause to worry. The high tide of prosperity will continue” - Andrew W. Mellon, Secretary of the Treasury.

Oct. 13, 1929: Ohio Economist Says Stock Prices Will Stay at High Level For Years to Come - Dr. Charles Amos Dice, professor of business organization at Ohio State

Oct. 16,1929: “FISHER SEES STOCKS PERMANENTLY HIGH” – Nobel laureate Irving Fisher, Yale economist

Oct. 25, 1929: “BROKERS IN MEETING PREDICT RECOVERY; Partners in 35 Wire Houses at Conference Agree Selling Has Been Overdone.”

Oct. 27, 1929: Brokers Believe Worst Is Over and Recommend Buying of Real Bargains – New York Herald Tribune


Oct. 29, 1929: Stock Market Crashes!Oct. 30, 1929: “Time to Buy Stocks” - John J. Raskob, one of the country’s leading industrial and political leaders

Nov. 22, 1929: SEES NEW BULL MARKET.; President of Philadelphia Stock Exchange Makes Predictions.

June 13, 1930: “The worst is over without a doubt.” - James J. Davis, Secretary of Labor.

July 6, 1930: ‘BUSINESS CYCLE’ SEEN AT NEW PHASE; Bankers Hold Downward Trend in Markets Indicates Recovery Is Near. DENY ANALOGY TO 1920-21 Economists Point to Superior Credit Conditions Now, Holding Easy Money Points to Revival.

Sept. 12, 1930: “We have hit bottom and are on the upswing.” - James J. Davis, Secretary of Labor.



$103b

1) 1929: Stock Market Crash2) 1930: Smoot- Hawley Tariff3) 1930 – 33: Bank Failures4) 1932: Revenue Act5) 1932 – 33: Roosevelt’s socialist/fascist policies6) 1937: Revenue Act

AD1

122

A A

A

B

B

B

C

C

C

DD

DE

EE FFF G

GG

July 1928 – July 1929: FED raises interest rates from 3.5% to 6%.

The Great DepressionToday most economists who have studied the period blame poor economic policymaking both in the United States and in other major industrialized countries.” - Ben Bernanke [current chairman of the Federal Reserve Bank], Principles of Economics, Third Ed. P. 474.

The Great Depression“Despite the devastating loss of wealth, chaos in our financial markets, and a loss of confidence so great that it nearly destroyed Americans’ fundamental faith in capitalism, the economy came back. Indeed, the growth between 1933 and 1937 was the highest we have ever experienced outside of wartime. Had the U.S. not had the terrible policy-induced setback in 1937, we, like most other countries in the world, would probably have been fully recovered before the outbreak of World War II.” - “Lessons from the Great Depression for Economic Recovery in 2009,” Christina D. Romer, Council of Economic Advisers [to president Obama], Presented at the Brookings Institution, Washington, D.C., March 9, 2009

The Great Depression“Let me end my talk by abusing slightly my status as an official representative of the Federal Reserve. I would like to say to Milton [Freidman] and Anna [Schwartz]: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again.” - Remarks by [Fed] Governor Ben S. Bernanke, At the Conference to Honor Milton Friedman, University of Chicago, Chicago, Illinois November 8, 2002, on Milton Friedman's ninetieth birthday.

Peak August 1929, Trough May 1933Real GDP falls 39%Real Consumption falls 29%Prices (GDP deflator) falls 23%Unemployment Jumps:

3.2% in 1929 25% in 1933 (21%Darby) 17% in 1939 (17% Darby)

Banking CollapseJuly 1929, 24,504 banks, $49 billion deposits. December 1932, 17,802 banks, with $36 billion. After Bank Holiday March 1933, 11,878 banks with $23 billion deposits.


9000 Banks suspend operations.Depositors and stockholders lose $2.5 billion = 2.4% of GDP


Money Supply Declines and there is a massive rise in realized real interest rates, over 10%.

Friedman and Schwartz blame inaction of the Fed for this decline---and hence for the depression.

Aggregate Supply & Aggregate Demand

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