Professional Documents
Culture Documents
and
Aggregate Supply
Business
Economic cycle
activity
Time
Facts About Economic Fluctuations
Real GDP Growth Rate:
GDP at FC (constant price) base year (1999-2000)
12.00
Business Cycle
10.00
8.00
6.00
4.00
2.00
0.00
-2.00
-4.00
-6.00
2
Trend Line or Potential Growth Rate of output
Facts About Economic Fluctuations
Business Cycles in India
PERIOD V 2001-2002
PERIOD VI 2007-2009
Facts About Economic Fluctuations
Business Cycle and Inflation rate
OPEC crisis
Asian Financial crisis
Business Cycles
P1
AD
Y
Y1
The model determines the Real GDP, the
eq’m price level and eq’m quantity of output
output (real GDP).
THE AGGREGATE-DEMAND CURVE...
Y=C+I+G+X-M
The Aggregate Demand Curve
The downward slope of the aggregate-demand
Price
curve shows that a fall in the price level raises
Level
the overall quantity of goods and services demanded.
AD=C+I+G+NX
P2
1. A decrease
Aggregate
in the price
demand
level . . .
0 Y Y2 Quantity of
Output
2. . . . increases the quantity of
goods and services demanded.
Aggregate Demand Curve: Why Slopes Downward
1. The Price Level (P) and Consumption (C): The Wealth Effect
2. The Price Level (P) and Investment (I): The Interest Rate Effect
When ↓P=> ↑M/P=> ↓i=> ↑ I=> ↑AD
3. The Price Level (P) and Net Exports (X-M): The Exchange-Rate
Effect
P1
D2
Aggregate
demand, D1
0 Y1 Y2 Quantity of
Output
Aggregate Demand Curve: Why Shifts?
Shift Factors in AD Curve
Q= A f(N,L,K,O)
Price
Level
Long-run
Aggregate
Supply curve
P2
2. . . . does not affect
1. A change the quantity of goods
in the price and services supplied
level . . . in the long run.
The most important forces that govern the economy in the long run are technology and
monetary policy.
B. Short-Run Aggregate-Supply Curve: SRASC
(Keynesian)
Price
Level
Short-run
aggregate
supply
P2
1. A decrease 2. . . . reduces the quantity
in the price of goods and services
level . . . supplied in the short run.
0 Y2 Y Quantity of
Output
B. Short-Run Aggregate-Supply Curve: SRASC
(Keynesian)
• If P > PE,
Revenue is higher, Production is more profitable,
so firms increase output and employment
Equilibrium A
price
Aggregate
demand
0 Natural rate Quantity of
of output Output
Long-Run Growth and Inflation
AD1980
Two Causes:
1. Shifts in Aggregate Demand
2. Shifts in Aggregate Supply
1. Shifts in Aggregate Demand
Event: Stock market
2. . . . causes output to fall in the short run . . .leading to recession
crash
Price Affects C, AD curve
Level
Long-run Short-run aggregate
aggregate supply, AS
supply
AS2
3. . . . but over
time, the short-run
P A aggregate-supply
curve shifts . . .
P2 B
1. A decrease in
aggregate demand . . .
P3 C
Aggregate
demand, AD
AD2
0 Y2 Y Quantity of
4. . . . and output returns Output
to its natural rate.
Question: Working with the model
Long-run Short-run
aggregate AS2 aggregate
supply supply, AS
B
P2
A
P
3. . . . and
the price
level to rise.
Aggregate demand
0 Y2 Y Quantity of
2. . . . causes output to fall . . . Output
Accommodating an Adverse Shift in Aggregate Supply
P3 C 2. . . . policymakers can
P2 accommodate the shift
A by expanding aggregate
3. . . . which P demand . . .
causes the
price level
to rise 4. . . . but keeps output AD2
further . . . at its natural rate.
Aggregate demand, AD
r2 P2
Money demand at
price level P2 , MD2
r 1. An P
3. . . .
which increase
Money demand at in the Aggregate
increases
price level P , MD price demand
the
equilibrium 0 level . . . 0
Quantity fixed Quantity Y2 Y Quantity
interest
by the RBI of Money of Output
rate . . .
4. . . . which in turn reduces the quantity
of goods and services demanded.
How Monetary Policy Influences Aggregate Demand
Changes in the Money Supply
C. War breaks out in the Middle East, causing oil prices to soar.
This event would reduce AS, causing output to fall.
Price
Level
Rs. 20 milion
AD3
AD2
Aggregate demand, AD1
0 Quantity of
1. An increase in government purchases Output
of Rs. 20 milion initially increases aggregate
demand by Rs. 20 milion . . .
2. The Crowding-Out Effect
• Q. If suppose the Central Govt spends Rs 20 million for buying
helicopter from HAL this year and money is financed through
borrowing from market , what will happen to AD and economy?
An ↑Govt Exp.=> ↑ i=>↓I=>↓AD.
This reduction in demand that results when a fiscal expansion
raises the interest rate is called the crowding-out effect.
Interest Price
Money 4. . . . which in turn
Rate Level
supply partly offsets the
2. . . . the increase in Rs.20 milion initial increase in
spending increases aggregate demand.
money demand . . .
r2
3. . . . which
increases AD2
the r
AD3
equilibrium M D2
interest
rate . . . Aggregate demand, AD1
Money demand, MD
0 Quantity fixed Quantity 0 Quantity
by the Fed of Money 1. When an increase in government of Output
purchases increases aggregate
demand . . .
B. Changes in Taxes(T)
• Q. If suppose the Central Govt spends Rs 20 million for buying
helicopter from HAL this year and money is financed through
raising Taxes (T) , what will happen to AD and economy?