you're gonna like this chapter because after what you've been through in the last two chapters it's much simpler but if simpler because you have been through the last two chapters so we're going to take all the learning that we did in the last two chapters and change the graph the aggregate expenditures graph look different than any other kind of graph we've looked at this semester and we're going to put that information back in a supply and demand graph that looks familiar to us but we have to be really careful when we do that because although the graph looks familiar and we understand that prices on the vertical and quantities around the horizontal it is different because it's aggregate it's the demand for all of GDP so it's not the press single price it's the price of all GDP so think that GDP Price Index that you calculated so the price level and then the horizontal axis is not the quantity of a single product but the quantity of all GDP so we just label it with real GDP another problem with the aggregate expenditures model that we saw in the last two chapters is that it assumed we were in the immediate short-run which is a time period too short for prices to change so all of the prices were static constant there was no way to see how price level might change when consumption or investment or government spending or net exports changed so we're going to take that learning and we're going to put it in a model that's a variable price model and that looks a little bit more familiar to us so just like we did in Chapter three when we were studying just supply and demand we're gonna look on the demand side but now it's aggregate demand then we'll look on the supply side but now aggregate supply then we'll put the two together to get our equilibrium price level and GDP so starting just on the demand side you know that we said people buy more at lower prices and less at higher prices that's still true because we have that downward sloping demand curve but the reasons for it is differe different so in Chapter three when we were looking at a single product the demand curve was based on three aspects one was the income effect we said as price level goes down our income could afford more the second was the substitution effect we said as price comes down we'll substitute out of and now substitute that's relatively more expensive and buy more of this good where prices going down and then the diminishing marginal utility we said as we get more and more units of a particular good each additional unit gives us less and less satisfaction none of those reasons are applicable here in the aggregate demand model so that applied to a single product demand curve but aggregate demand weights the demand for everything the economy produces those three reasons will not apply instead we have these three new reasons so the real balances effect works like a wealth of fact we used to call it wealth effect I think that's a little clearer remember wealth was not income it was our past accumulated income and how we hold our well some people hold their wealth in real estate if you own a home then you're accruing some equity in that home and you're holding your wealth that way or perhaps you're invested in mutual funds with your 401ks at work however it is that you're holding your wealth if wealth comes down that affects how much we're going to demand of GDP if you can think back to the Great Recession in two thousand seven eight nine then you'll remember that house prices came down and our 401ks were cut in about half so when that sort of situation happens people get nervous and they start buying less stuff so that's why the aggregate one of the reasons why the aggregate demand curve slopes downward another reason is the interest rate effect so think about big purchases you might want to buy like houses or cars or refrigerators something that you might have to sign out so instead of pay cash bar do you care what the interest rate is well sure we want interest rates to be low when we borrow money so that we won't have to pay as much money back so on that aggregate demand curve where the vertical axis is price level the price level that would be talking about here is the price of borrowing money so when that price is high we don't borrow as much so GDP it will the equilibrium will be at a lower level but as interest rates go down that price level goes down and then people start borrowing more for houses or cars or refrigerators and then the last is the foreign purchases effect so this is other countries people in other countries buying the goods and services that we produce here so our export if our price level is coming down it makes sense that foreigners will purchase more of our GDP so these are the three reasons for that downward sloping aggregate demand curve and it's different than it was for the single product demand curve so now we're gonna draw the aggregate demand curve and we're gonna see that it's downward sloping just like it was for the single product demand curve but on the vertical axis we don't have price of a single product it's price level like your GDP price index that we calculated back in Chapter seven and the horizontal axis is not the output or quantity of a certain good it's the real domestic output GDP the quantity of everything we produce in the nation so then we start thinking about what could shift aggregate demand curve do you remember when we shifted the single product demand curve to the right we were increasing demand for that product that learning is still going to hold here if we shift that aggregate demand curve to the right it means we're going to be perching purchasing more GDP at all possible prices and we think about well what can cause that well anything that causes us to change our aggregate expenditures will shift our aggregate demand curve if we're spending more it's just sit to the right if we're spending less it shifts it to the left so remember aggregate expenditures was C plus IG plus G Plus X in so C that was consumption household spending I it really should have a subscript G but investment capital I was investment capital G was government X n is exports minus imports so if how much households or businesses or government or the amount of exports that we have or imports changes then that aggregate demand curve will shift to the right or to the left depending on if we're increasing spending or decreasing it when we change spending remember we have the multiplier effect remember the multiplier was based on our marginal propensity to consume so our multiplier was one divided by the NPS marginal propensity to say so when we shift spending the multiplier is going to kick in and cause that curve just shift even further to the right or even further to the left so look at the lighter colored aggregate demand one if we think about let's see let's let's lower interest rates how would you expect lower interest rates to shift this aggregate demand curve well if interest rates go down households will buy more right buy more houses buy more cars anything that they would have to borrow money to purchase but businesses will buy more capital equipment to remember the investment decision was for the right of return to be greater than the interest rate so if interest rates go down there'll be more projects where the rate of return is greater than the interest rate so that initial increase in spending shifts that aggregate demand curve to the right that shows our increase in spending and then the multiplier kicks in and that's just our aggregate demand curve even further to the right so a shift from 81 to 82 is an increase in spending and then the multiplier effect so let's think about what could cause 81 to go to 83 what could cause a decrease in spending well anything that affects consumption investment government or net exports so we could think about let's see what if let's see the investment curve was dependent on things like acquisition maintenance and operating cost or a change in resource prices to remember all of that so we think about something that affects investment negatively would shift that curve to the left something that effect consumer spending negatively would shift that curve to the left let's just think about expectations on households and businesses what if people get worried about a coming recession do you think they'd spend more or when they spend less well if we're worried about a coming recession we're going to spend less so that's going to shift our aggregate demand curve leftward and that same multiplier effect is going to kick in so here's the list you've already seen these lists so we really don't have to do this again because we did this this particular list was in Chapter ten and we'll see things that affect household spending that was in Chapter ten things that affected investment spending was in chapter 11 and then government and net exports were also in chapter 11 so we have seen this before so anything that affects consumer wealth household borrowing consumer expectations are even our personal taxes change how much households can spend right if our taxes go up is that a good thing or a bad thing well I think it's a really bad thing when my taxes go up so if I redraw that aggregate demand curve remember we had price level on the vertical axis and we have GDP down here on the horizontal axis remember the aggregate demand curve was downward sloping so I'm going to label this ad one so now as I draw this new ad to curve shifting this to the shifted aggregate demand curve to the right is that an increase or a decrease in spending well it's gonna be an increase right so what do these things could change that would cause that increase in spending would consumer wealth be going up or down what would have to be wealthier if we're trying to increase our spending household borrowing would we be borrowing or would we be paying back well if we're increasing spending we must be in the borrowing pace would we expect be expecting a recession or would be would we be expecting a really good economy where people have jobs and that we're moving forward we'd be expecting something good when our taxes be going up or what our taxes be going down well we're gonna spend more it must be that our taxes are going down so if instead of moving to a d2 it leftward 283 then just the opposite of everything we said would be true here household wealth must be going down or would be paying back our debt rather than going into more debt would be expecting a recession and our personal taxes would be going up so we looked at this rule specifically here with consumer spending it could be a change in consumer spending but it also could be a change in one of the other components of aggregate expenditures it could be consumer spending business spending government spending or net exports so this is the same thing but with respect to investment spending so we could draw that graphic in a price level here remember what went on the horizontal right GDP to remember the shape of the aggregate demand curve downward sloping yep so let's do this one is number one so real interest rates so if interest rates are going up which way would we shift aggregate demand of interest rates were going up would be shifting aggregate demand to the left right and just rates were going down would be shifting it to the right so expected rates of returns would also affect how much investments how much business is invested so remember we only invest if the rate of return is greater than the interest rate so if rates of return change it affects how much we're going to be investing so let's say that and you've seen this whole list back in Chapter ten so we don't spend need to spend a lot of time here but let's say that business is expectation about future business conditions what if their expectations are that were going into a recession which way would you expect the aggregate demand curve to shift well you would expect it to shift back here right that's a decrease what if business taxes are going down what business taxes are going down well right would expect the aggregate demand to shift to the right so it could be a change in government spending I'm not going to draw the graph for you again but it's the same concept what if government spending is changing because we were going into a war and so government really ramped up spending with respect to preparing for war goods well then that was shift the aggregate demand to the right yes and piece times it might shift back to the left maybe perhaps there'd be less military spending and then that last one is net export spending and we talked about this in our last chapter so if our trading partners people who normally buy a lot of our exports if they're experiencing prosperity and their economies are good then they're going to buy more of our stuff and our aggregate demand will shift to the right if they're experiencing recession then they buy less of their stuff and less of our stuff and so that aggregate demand curve would be shifting to the left we also talked about what would happen if exchange rates change so last time we did dollar appreciation let's do depreciation so if the dollar depreciates against a certain nation's currency then that means we can't buy as much of their stuff but they could buy more of our stuff so if they can buy more of our stuff our exports would go up our imports from them would go down but our exports would go up and when imports go down and exports go up that shifts our aggregate demand curve to the right so just like we did in Chapter three first we looked at at demand now we're going to look at supply but this is aggregate supply the supply of all GDP while aggregate supply is very dependent on time what time frame were in so we just kind of need to memorize these differences these definitions here the immediate short-run is a time period too short to be able to change any of our resources price levels are going to be fixed in the immediate short-run it's just a time period too short to be able to make changes we don't really work in the immediate short-run we work all the time in the short-run there's an old quote by John Maynard Keynes remember that we're in Keynesian economics right now and john maynard keynes said we're gonna stay in the short-run as we study this topic because in the long run we'll all be dead he kind of felt that way that we never actually got to long-run conditions because as soon as you would get there circumstances things would change and you'd just be in a new short-run world so we're to focus on the short-run in the short-run we can change some of our resources but we can't change all of them so when we look at these topics we're really just going to talk about labor and capital it's always about labor and capital in the short-run it's easy to change our labor we can ask people to work overtime or we can hire more people or we could lay people off labor is pretty easy to change pretty quick capital on the other hand is not remember capital is all of the manufactured aids that we need to produce our good or service so it's not people and it's not natural resources so when we talk about capital being very slow to change we're typically talking about the physical work space so think about the building itself that you're in so in the short-run labor can change but capital won't change in the short-run technology doesn't typically change in the short run it takes a while to develop that new technology in the long run everything can change so in the long run we can change all and all labor all capital there is no restrictions in the long run think about starting your business and you rent your building and you have to sign a contract for that so you might have rented your building you might have a contract for five years if that's the case then you were in your short-run until that contract expires so it might be five years before you can reach a long-run condition where you could get out of that contract so here's a graph of the aggregate supply curve in the immediate short-run we're not going to use this one so you don't have to give it a lot of thought but price level is on the vertical GDP is on the horizontal and notice that the short-run is a time period too short to change prices so we could change our labor and affect how much we produce but we can't change the price level this is not the graph I want you to concentrate on this is the graph that I want you to concentrate on so we're gonna stay focused on the short-run for our entire course so in the short-run as you increase output notice that the price level goes up I actually want you to extend this supply curve to the horizontal axis pretend that drew that is a nice straight line sounds a little better so down here in the horizontal region this region just right here as we increase output notice that prices do not go up as we increase output prices do not go up and then in the upward sloping region this region of the original curve in the upward sloping region as we increase output prices do go up and then in the vertical region go ahead and extend this curve I wish I could draw it straight up pretend I'm drawing it straight up you're gonna have to really pretend because that is hard to do with the mouse so in that vertical region of the aggregate supply curve notice that if demand kept increasing and we wanted to produce more and more of this good the only effect it would have would be on price we're absolutely at capacity we can't produce any more in that vertical region so increases in demand just cause price level to go up notice that we're always told where full-employment is so when you see this QF you know that that's the level of full employment so we want aggregate demand oh that's really bad let me try this so we want aggregate demand to intersect right there at that full employment that's the goal we want aggregate demand to intersect aggregate supply at full employment the full employment is the level of GDP that is enough to generate enough jobs to get us fully employed that's where we want to be think about if we were at a low level of aggregate demand somewhere down here well this aggregate demand is always going to be recessionary because it's not enough spending to get everybody jobs so anywhere to the left of the full employment intersection spot here anywhere a left of here is going to be recessionary that means we need to be able to increase spending to try to get this aggregate demand to shift towards full employment but what if our aggregate demand curve was way up here so if our aggregate demand curve is to the right of the full employment level anywhere to the right of the full employment level then we're going to be expecting inflation so we have an inflationary aggregate demand curve and the goal is going to be to shift it left to get it to come back down to full employment level notice if that if that happened notice how far the price level would drop and that would be the goal to control inflation so here's a higher aggregate supply curve in the long run no we said we're never probably in a long run situation because as soon as you get there it changes so here's our full employment level of output I told you that's our goal so the ideal would be that we would be producing at this full employment level in the long run so then we think about what could cause the aggregate supply curve to shift what would cause it to shift to the right to increase aggregate supply or to the left to decrease aggregate supply so the primary factors that we think of to shift aggregate supply is time how much time do producers have to respond to changes in aggregate demand or a change in the per unit production cost so remember if an employer's production costs go up that negatively affects their profit levels so they'll begin to decrease aggregate supply they'll begin to shift it to the left what could cause per unit production costs to go up well think about how a significant increase in minimum wage would affect employers suppliers if minimum wage goes up is that a good thing or a bad thing from the perspective of suppliers employers well for them it's bad right their labor costs are going to go up significantly if they use minimum wage labor that will cause I forget supply to shift to the left it could be a supply shock like all prices going way up when oil prices go up it has a domino effect all through our economy whether oil is directly used in the production of the good or service like anything made out of plastic or whether it's just a distribution and transportation costs so there are some overarching things that affect all suppliers that could cause that per unit production cost to shift right or left we'll also talk about changes and productivity okay so remember we're going to add on to our supply curves but it doesn't change the overall effect we were going to add the vertical region just have trouble drawing that straight dunna and the horizontal region but without doing that to each curve you see the original curve is one if something happens that is a positive thing from the producers perspective and it's overarching it's not a single producer it's the production of every good or service we produce in the economy then that causes them to increase their aggregate supply shift it to the right if something happens that negatively affects producers then that causes them to decrease their production to decrease the total aggregate supply of everything we produce so that would shift the curve to the left so then this just breaks down what we already talked about it could be that the input prices resource prices factors of production those all are synonyms inputs resources factors of production all synonyms they say the same thing if the resource price has changed if they go up is that a good thing or a bad thing for producers it's bad so that causes that aggregate supply curve to shift left it really doesn't matter whether it's domestic or imported if the prices are going up it's bad for producers shifts to the left if the prices are going down it's good for the producers shifts it to the right and then I told you we were going to talk about productivity so once you de get to think about productivity from the producers perspective do you want your employees to be more or less productive well I want them to be more productive right well if our employees become more productive we will shift our supply curve to the right it will be more profitable for us to produce more if something happens to decrease productivity low morale whatever the situation might be illness if something happens to decrease productivity then the aggregate supply curve shifts to the left so the way that we measure productivity its total output divided by total input so if you think about measuring it strictly from a Labour point of view the input is how many people you have working and the output is how much product gets produced so if we're a pizza maker just to put it on a micro scale just thinking about a single producer it were a pizza maker and we make a hundred pizzas a day and we employ ten people then the productivity factor would be calculating as a hundred divided by ten would be ten but if we got some new technology and it let our people be more productive maybe we can make 200 pizzas a day with those same 10 people so output would be 200 divided by 10 and now it's 20 so our productivity factor would have changed from 10 to 20 if productivity is increasing like that example and that can be applied on a much broader scale not just pizza producers but that technology perhaps had applicability in a lot of different industries then the aggregate supply curve would be shifting to the right so how do we measure that per unit production cost it's that same idea the total input cost so that would be our total cost of our labour divided by the total output so just the input cost divided by the output will give us a higher total per unit production cost so legal and institutional environment I didn't think to mention this one earlier when I was giving you an overview if the government does something to change the Institute some sort of new law or policies perhaps it's an Environmental Protection Agency policy that affects businesses or changes business taxes that will often also shift the supply curve right or left so taxes remember that's money from the business to the government so a business taxes go up is that good or bad from the perspective of the producers well it would be bad right so business taxes are going up and aggregate supply is shifting left but what about subsidies so subsidies is money from the government to the business so if our subsidies are going up maybe a milk producer maybe the milk industry they get a lot of a lot of agricultural products have a lot of subsidies if subsidies are going up then that's a good thing from the perspective of the producer and they shift their aggregate supply curve to the right producing more at all possible prices and there's some new environment environmental protection procedures laws policies that businesses have to comply with even though it's not profitable for them that will begin to shift our aggregate supply curve to the left and then we're ready to put both pieces together we know all we need to know about aggregate demand we know about aggregate supply it's never helpful to graph just one of those on a graph we need both of them on one graph because it's the interaction between buyers and sellers that actually give us information about the economy so let's put both our demand curve and our supply curve on one graph and we see that open circle that intersection spot that equilibrium and that will be our equilibrium price level an equilibrium output so look at the schedule on the right notice that that price level of 100 the real output demanded and the real output supply is the same number so that's our equilibrium it doesn't say that that five hundred and ten billion dollar level is the full employment level so we can be an equilibrium and not be at full employment we want to be at full employment but we may have to increase aggregate demand or decrease aggregate demand or shift aggregate supply until we meet that full employment equilibrium but here's our equilibrium at five ten whether that's full employment or not they're wanting you to look at a disequilibrium spot a spot where you're not in equilibrium so they gave us a an example here at a price level of 92 well at a price level of 92 how much is being supplied that 502 mm-hm and how much is being demanded by 14 we know that at any price level below the equilibrium price we're going to get a shortage meaning aggregate demand is going to be more than aggregate supply so here we see that 514 minus at 502 we have a twelve billion dollars shortage we can interpret those exactly the same way we did in Chapter three okay do you remember doing in Chapter nine demand-pull and cost-push inflation this is the exact same demonstration it's just that now you have some understanding of the aggregate demand and aggregate supply curves so we'll see it here again okay so we have this original equilibrium of ad one with our aggregate supply curve here and so our price level was P one and look it says we're at the full employment level see the QF we're at full employment level doesn't have to be but it says we are the aggregate aggregate demand increased shift it to the right so now we're at this 82 level up here that is our demand pull inflation demand pull inflation was caused by excessive demand do you remember that see if I can get that written excessive demand it's when the economy is doing great it's overheated people just have jobs they have money they're just working and spending and working and spending and that's increasing that aggregate demand and it increases faster than production levels can change notice the aggregate supply curve isn't shifting here and so during that time period before our aggregate supply can respond in that short-run fully respond then it's driving that price level up here's our aggregate supply aggregate demand curve this time aggregate demand is shifting to the left so we start out at this original equilibrium spot and so at price level one and at full employment something happens to cause people households businesses government and it exports some sector of the economy or more than one sector to decrease their spending which shifts the aggregate demand curve to the left theory will tell us that prices will go from A to C so price level goes down and we produce less we're at q2 but sometimes prices are sticky and when prices are sticky production levels go down but prices don't have you noticed that sometimes prices are downwardly inflexible sticky they don't go down like theory tells us that they will there's a lot of reasons why producers are hesitant to lower their prices so we might in a leftward shift of aggregate demand go through at least some time period and demand goes down but prices don't eventually prices will probably decline if the leftward shift in aggregate demand is long enough so this slide shows us reasons why producers might not lower prices as the model predicts that they will so prices are inflexible downward when producers don't expect that that left would shift in aggregate demand is going to be a long term shift because it's expensive to lower prices and they may not even be able to be lowered so let's think about why we used to see a lot of price wars we don't see that so much anymore we used to be able to drive by two gas stations across the street and one would lower their price and so the other would lower their price and so other one would respond back and forth a price war with electronic information being so widely available we don't see that happen much anymore Airlines still do it to some extent American Airlines and Southwest Airlines will see them get in a tip for tat kind of situation but again it doesn't happen as often as it used to menu Costas reflects the actual cost it would take an employer to change his prices that might be like we call it menu because it might literally be reprinting a menu in a restaurant but all businesses if they change their prices incur some cost just imagine changing all the inventory tags about 80% of most businesses cost is their labor cost no that's just a generalization but it's pretty accurate and if we can't change the price of our labor we probably can't change the price of the product or the service that we're producing whether it's because our labor is under contract like faculty members at an academic institution or union contracts if there's contractual labor costs then we're not gonna be able to lower our labor cost we're probably not going to be able to lower our prices efficiency wages is the idea that there's a certain magical wage that we can pay our people that will get the most productivity from them and there's a lot of research that businesses do to find that efficiency wage what is it that I can pay my people that won't bankrupt me and yet we'll get the greatest productivity from them if I have found my efficiency wage I'm not real inclined to change it and if I don't change my wages I can't change the price and then of course we can't pay people lower than minimum wage just a global perspective it's the difference in between actual and potential GDP so when you see the negative side you would be expecting some cyclical unemployment in those nations so we looked at demand pull inflation again here's another look at cost push inflation which hopefully you remember was a leftward shift and AG supply what caused cost push inflation do you remember so cost push inflation is always caused by an increase in per unit production cost so an increase in production cost per unit meaning every unit we produce cost more than it used to increase in per unit production cost I know you think I'm the slowest ever riding with this mouse and I am so a leftward shift in our aggregate supply curve pushes a possible we knew that it's called inflation so we knew the price level was going up and really wants you to notice what's happening to GDP when we increased the aggregate demand curve prices went up but we also increased GDP but if we have an affliction that's caused by increases in the per unit production cost and so shifts our aggregate supply curve left prices go up but GDP goes down notice we're no longer at full employment well that's a sad situation I want you to think about that people are losing their jobs and things are costing more it's it's much harder to recover from cost-push inflation than it is from demand-pull because cost-push inflation is going to end in recession remember a recession is any level of production of GDP that's below that full employment so the decrease in aggregate supply is causing us to produce less so GDP is going down so when GDP goes down we define that as a recession we have an increase in AG demand there's our aggregate supply price level would be going up but look what could happen if at the same time we have the increase in aggregate demand if we can also increase aggregate supply we could get an even further increase in GDP but mitigate the inflation so let me say that again I know it's hard to see how that come at the same time as start out at a s1 ad one see the original equilibrium at a that's where we were then aggregate demand the increase pushing us to B that gave us more GDP but really higher prices if the government could do something when we have those increases in aggregate demand to also increase aggregate supply we'd get even more GDP with more stuff but we'd get it at a much lower price level so the goal as aggregate demand is shifting to the right is for the government to also be helping aggregate supply shift to the right as well so we're really finished with this chapter this last word in this edition of the textbook is focused on the Great Recession of 2007 8 9 and as I record this I'm thinking that might not be the recession that you'll be thinking of as you're listening to this in the future but in 2007 8 9 we went into that deep recession primarily caused by well triggered at least by the collapse and home prices because of some bad lending procedures the Federal Reserve responded with changes in monetary policy that lowered interest rates really to almost zero for a long long time that would get people spending right lower interest rates people buy more houses cars etc businesses buy more capital equipment that should that aggregate demand to the right which is what we definitely needed and then we also got huge increases in fiscal policy with government spending increasing again and again and again with different stimulus packages directly into households and businesses to try to shift that aggregate demand curve to the right all of that changes in monetary policy and fiscal policy to try to alleviate the effects of that recession and get that aggregate demand curve to shift to the right didn't have as large effect as we were hoping the GDP growth was slow but it was steady for a long time so it doesn't always happen right away it happens over time we will see that same response and effect in other recessions that we encounter