Chapter 23 - output and prices in the short run Flashcards Preview

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Flashcards in Chapter 23 - output and prices in the short run Deck (16):
1

Exogenous Changes in the Price Level

Effect on Consumption and Net Exports

Rise in price level
- lower real value of wealth held by the private sector
- decrease in autonomous C
- AE curve shifts down
- Y decreases

Rise in Price level
- Canadian goods become MORE expensive relative to foreign goods
- decrease exports
- increase imports
- Net Export function shifts down
- AE function shifts down
- Y decreases
(assuming parallel shift in AE)

Fall in price level
- rise in real value of wealth held by the private sector
- increase in autonomous desired C
- AE curve shifts up
- Y increases

Fall in Price level
- increase exports
- decrease imports
- shift net export function Up
- AE function shifts Up
- Y increases

2

Deriving the Aggregate Demand Curve

Relates price level to output

- created by plotting all equilibrium points (actual Y = desired AE) at respective price levels
- x axis = real GDP
- y axis = price level

Negatively sloped
- rise in price level causes AE function to shift down, leading to a movement along the AD curve (fall in Y)
- fall in price level causes AE function to shift up, leading to a movement along the AD curve (rise in Y)

*change in price level causes movements along the AD curve

3

Shifts in the AD curve (caused by determinants OTHER than price)

Called AD shock

1) increase in autonomous AE
- shifts AE curve Up
- increases real GDP
- at the same price level, there is increase in Y
- shift AD curve right

2) decrease in autonomous AE
- shifts AE curve down
- decreases real GDP
- at same price level, there is a decrease in Y
- shift AD curve left

4

Simple Multiplier vs. Multiplier

Simple Multiplier measures the horizontal shift in the AD curve (if AS curve was horizontal and price level was constant)

= 1/(1- Z)

Multiplier measures the change in the macroeconomic equilibrium (AS = AD)
- smaller than simple multiplier (considers price changes)

5

Aggregate Supply Curve (AS)
- explains why Price level changes (endogenous)

Assumptions

Slope?

Assume:
- technology is constant
- factor prices are constant

Positively sloped:
- As output increases, unit cost increases
- must charge higher price to cover higher unit costs
- slope gets steeper because...

1) low levels of real GDP = flat, horizontal portion
- excess capacity (some plant and equipment are idle)
- no extra cost to increase output

2) beyond capacity = steeper slope
- unit costs rise rapidly
- higher-cost production methods are used, which require higher selling prices to cover them

6

Shifts in the AS curve

Called Aggregate Supply shocks

1) changes in input prices
- as input prices increase, AS curve shifts left due to reduced profitability
- as input prices decrease, AS curve shifts right due to increased profitability

2) changes in technology
- improvements in tech = reduced unit costs = increase in AS shift right
- deterioration in tech = increased unit costs = decrease in AS shift left

7

Macroeconomic equilibrium

Changes in Macroeconomic equilibrium

Positive shocks?

Negative shocks?

Occurs when AS = AD

Changes in equilibrium are due to positive and negative shocks

Positive shocks: increase equilibrium GDP

Negative shocks: decrease equilibrium GDP

*AD shocks cause both price level and real GDP to change in the same direction

Demand Shocks:
- changes in G, I, exports, and consumption (shifts both AE and AD curves)

Supply shocks:
- changes in factor prices, wages, technology

8

Importance of the shape of AS curve


FLAT RANGE:
o No change in price level due to AD shock
o Change in Y = size of the simple multiplier

Intermediate Range (positively sloped);
o Increase in price level due to AD shock
o Change in Y is SMALLER than simple multiplier

Steep range
o Any change in AD leads to a SHARP change in PRICE level
o Multiplier nearly 0 (little or NO CHANGE in real GDP)

9

Slope of AS curve and changes in AD?

The effect of any given shift in AD will be divided between a change in real output and change in price level

Flatter AS:
- smaller price effect
- larger output effect
(we want this)

Steeper AS:
- larger price effect
- smaller output effect

10

Shape of AE and AD curve relationship

If Z is large....

If Z is small...

If Z is large:
- steep AE curve
- when price changes a little bit, there is a large change in real Y
- therefore, AD is flat
- large simple multiplier also means large shifts in AD curve

If Z is small:
- flat AE curve
- when price changes a lot, there is a small change in real Y
- therefore AD is steep
- small simple multiplier also means small shifts in AD curve

11

World Price of oil (country is exporter and supplier)
Ex: Canada

Shifts AS curve:
- world oil is an input
- increase in price of oil, shift AS left
- decrease in price of oil, shift AS right

Shifts AD curve (exporter):
- increase in price of oil, increase in the value of exports = shift AD right
- decrease in price of oil, decrease in value of exports = shift AD left
*wouldnt be a decrease in AD due to more expensive domestic good

12

Algebraic version:

YAD = 710 - 30P + 5G

YAS = 10 + 5P - 2Poil

Why does G enter positively in YAD?

As government spending increases, this causes AE curve to shift up, which increases Y

Therefore at the same price level, Y is higher

So AD curve shift to the right and overall demand in the economy increases

13

Algebraic version:

YAD = 710 - 30P + 5G

YAS = 10 + 5P - 2Poil

What is the value of the simple multiplier?

Simple multiplier * change in autonomous spending measures the horizontal shift in the AD curve

(assume price level is held constant, or AS curve is horizontal)

So if G increases by 1, YAD increases by 5

Therefore simple multiplier = 5

14

Algebraic version:

YAD = 710 - 30P + 5G

YAS = 10 + 5P - 2Poil

Why does Poil enter negatively in YAS?

Poil is an input

So as Poil increases, AS curve shifts left (decrease supply)

15

Algebraic version:

YAD = 710 - 30P + 5G

YAS = 10 + 5P - 2Poil

Equilibrium Y* = 110 + 0.8G - 1.8Poil
Equilibrium P* = 700/35 + G/7 + 2/35*Poil

What is the effect of a change in G on Y* and P*?

As G increases, Y* increases (enters positively into Y* equation)

As G increases, P* also increases (enters positively).

This is what you would expect from a downward sloping AD curve and upward sloping AS curve

16

Algebraic version:

YAD = 710 - 30P + 5G

YAS = 10 + 5P - 2Poil

Equilibrium Y* = 110 + 0.8G - 1.8Poil
Equilibrium P* = 700/35 + G/7 + 2/35*Poil

What is the effect of a change in Poil on Y* and P*?

An increase in POil causes Y* to decrease (enters negatively)

An increase in Poil causes P* to increase (enters positively)

Therefore, if POil increases, this affects only Yas in THIS PARTICULARLY MODEL (so economy is not an exporter of oil)
- AS shifts left
- P* increases
- Y* decreases

This is what you would expect from this model!