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

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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

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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?

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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?

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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*?

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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

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