Chapter 4: Aggreagte demand and aggregate supply and their interaction

First chapter of part 2 of the book: A study of the whole economy. The nature of that aggregate demandand aggregate supply and how they interact to affect output, unemplyment and inflation.

Aggregate demand(AD): total demand for a contry's goods and services at a given price level and in a given time period.

Calculate AD: C + I + G + (X – M)

The components of aggregate demand

C = Consumer expenditure:

• Real disposable income

• Wealth

• Confidence and expectations

• The rate of interest

• Age

• Distribution of income(give from the rich too the poor, bcause poor spend a higher%)

• Inflation

(Saving:(stop buying things)

• Real distposable income(higher income=higher savings)

• The rate of intrest

• Confidence and expectations about the feature

• Savings schemes(contractual)

• Range of financial institutions(put their money somewhere to save them)

• Government policies(tax free schemes?)

• Age)

I = Investment: (from companyes when:)

• Changes in real distposable income(increasing → demand for goods/services increases)

• Expectations, feel optimistic

• Capacity utilisation: the extent to which firms are using their capital goods

• Current profit levels: provide the finance to invest or contribute to firms optimism about feature.

• Corporation tax: tax on a firms profit

• The rate of interest

• Advances in technology: unit cost would fall.

• Price of capital equipment, reduction in the price of.... → more money to expand their capacity

G = Government spending:

• War, terrorists etc, can increase government spending

• Voters pressure on the government to spend money on health, education transport

• Level of economic activity in the economy, high unemplyment → G rise its spending

• Governments view on the extent of market failure and its ability to correct it

(X – M)= Net Exports

• Real disposable income abroad

• Real disposable income at home

• The domestic price level. Value of export might be higher than imports and vise verca.

• The exchange rate: price of one currency in terms of another currency

• Government restictions on free trade. Tariff: A tax on imports.

The realationship between aggregate demand and the price level

AD is inversely related to the price level. A rse in the price level causes a fall, contraction, in aggregate demand and a fall in the price level results in a rise or extension, in aggregate demand.

AD is downward sloping:

1. The wealth effect

2. The rate of intrest effect

3. The international trade effect

Aggregate supply: AS: The total amount that producers in an economy are willing and able to supply at a given price level in a given time period.

Shifts in the AS curve

• Main cause- short run: Change in the costs of production

• Main cause- long run: Productive capacity: Changes in the quantitu and quality of resources.

Def:

Productivity: Output/production, of a good or service per worker per unit of a factor of production in a given time peroid.

Privatisation: Transfer of assets from the public to the privvate sector.

Macroeconomic equilibrium: A situaton where AD equals AS and real GDP is not changing.

(Real GDP:the contry's output measured in constant prices and so adjusted for inflation.

Demand pull: AD shift to the right

Cost push: AS shift to the left

The circular flow of income: Movement of spending and income throughout the economy.

Income earned by households is spendt on buying goods/services from firms. Or going to:

Leakages: (withdrawals of possible spending from the circular flow of income) Savings, imports and taxes.

Firms use on production and:

Injections: additions of extra spending into the circular flow of income: Investment, government spending and exports.

The multiplier effect: The process by which any change in a component of aggregate demand results in a greater final change in real GDP.

Changes in AD:

Effected by the output of an economy, unemplyment and inflation:

• the size of the intial change

• the size of the multiplier

• the orginal level of economic activity.

Changes in AS:

Depend on the size of the change and the initial level of economic activity. An increase in AS occourring when the economy is at, or close to full capacity will raise the output of the economy and lower the price level. Rises mainly due to advances in technology and improved education.

Changes in AD and AS

AD grows more rapidly than the growth in productive capacity → inflation.

Overheating: The growth in AD outstripping the growth in AS, resulting in inflation.

Output gap

def: The difference between an economy's actual and potential real GDP. (when an economy is not producing at full capacity.)

Trend growth: The expected increase in potential output over time.