Unit+Three

**__A. Aggregate Expenditures__**

 * 1. Keynesian Equilibrium**

Keynesian economics began during the Great Depression and explained the lingering unemployment. John Maynard Keynes developed this theory. He stated that wages and priced were highly inflexible so therefore changes is prices and intrest rate would not bring the economy back to full employment.

The basic Keynesian model is that:
 * Aggregate expenditures= planned consumption+ planned investment+ Planned government expenditures+ Planned net exports**

Keynesian epuilibrium occurs when: **Planned Aggregate Expenditures=Current output**

If total **Aggregate Expenditures< current output** then the firm will obtain unplanned inventories and will cut back on output and employment. If total **Aggregate Exppenditures>current** **output** then the inventories for the firm will fall and the bussiness will respond with an expansion in output.


 * Keynesian Equilibrium Model**



2.**Multipliers** represent the additional income that results from an increase in spending, investment, etc. These multipliers are not in a one to one ratio. For example, an increase in investment may cause a proportionally greater increase in income. Three common examples are as followed:


 * Government expenditure Multiplier=** 1/(1-MPC) OR 1/MPS
 * Investment Multiplier=** 1/(1-MPC) OR 1/MPS
 * Tax multiplier**= -MPC/(1-MPC) OR -MPC/MPS

MPC=change in consumption/change in disposable income MPS=change in savings/change in disposable income
 * Remember that:

The investment multiplier is ALWAYS equal to the government expenditure multiplier. The investment and government spending mulitplier are ALWAYS positive. The tax multiplier is ALWAYS negative.
 * ALWAYS** remember that :

3. Effects of investment spending decisions on national output

Any increase in investment spending will cause an increase in the output or GDP. As a result, this graph shows that the increase in the Aggregate output from Y0 to Y1 will cause the aggregate demand curve to shift from AD0 to AD1



Any decrease in investment spending will cause an decrease in the output or GDP. As a result the Aggregate demand curve will shift from YE to Y2 and shift the aggregate demand curve from AD to AD2.

4. **Inventory changes in response to difference between aggregate expenditures and income**


 * Inventory: is the goods and materials that are held in stock by a business. If a good could be produced instantaneously then there would be no need for inventories. However, since most goods take a period of time to manufacture and deliver, businesses create goods in atnticipation of future sales.
 * Businesses strive for an optimal inventory level to insure that goods are available when the demand arises. However, businesses also want to make sure that the investment in the inventory is kept to a minimal.
 * If there is a higher than expected demand for a product, in the short run the supply will be too small resulting in a reduction in inventory. The business will have to produce more of this product in the long run in order to increase the supply or they will loose sales because the customer will go to a competiter. Conversely, if demand is lower than expected inventory levels will increase.
 * These inventory changes are directly related to the differences between aggregate expenditures and income. Income functions as a product to the demand, becase if people have greater income they are more likely to buy more. The aggregate expenditures relate to the supply side. In order to create a supply you need to spend money or expenditures.
 * Therefore fluctuations in aggregate expenditures or income cause inventory levels to increase or decrease in the short run. This requires bussinesses to adjust the levels of expenditures to bring the inventory back to the optimal level

[|Some fun info on aggregate expenditures]

[|helpful info on understanding inventories]

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__B. Aggregate Demand__

 * 1) Aggregate demand is the amount of real output (real GDP) buyers desire at each price level. It is the TOTAL amount of final goods and services demanded by buyers at each price level, while plain old demand is the number of units of a particular good or service desired at each price. Although demand and aggregate demand both slope downwards, the units of measure for each graph are different:
 * 2) //**Aggregate Demand Curve**//

//**Demand Curve**// Consumption + Investment + Government Spending + Net Exports=AD=GDP
 * 2. Components and Determinants of Aggregate Demand**
 * C + I + G + N**


 * Consumption** is the amount of money people can and will spend on goods and services. Consumption changes with disposable income, income available after taxes. An increase in disposable income will increase consumption and shift the aggregate demand curve to the right. A decrease in disposable income will decrease consumption and shift the aggregate demand curve to the left.


 * Investments** are affected by interest rates. An interest rate is the cost of borrowing money. As interest rates rise, investments decrease, and aggregate demand shifts to the left. When interest rates fall, investments increase, and the aggregate demand curve shifts to the right. Think of interest rate as the cost of a good, money. As the cost increases, the demand for that particular good decreases. All else equal, this causes aggregate demand to decrease as well.


 * Government spending** is basically just consumption by the government. As it decreases, aggregate demand decreases, and as it increases, aggregate demand increases. The government will sometimes purposely increase to decrease spending to control inflation. See fiscal policy for more information.

N = Imports - Exports
 * Net Exports** are the total value of all goods exported from the United States. It is basically consumption of domestic goods by international consumers. As net exports decrease, aggregate demand decreases. The opposite is true if net exports increase.

3. Why the AD curve slopes downward
The aggregate demand curves slopes downwards because the relationship between price levels and output is inverse. In other words, as price levels increase, AD decreases, and as price levels decrease, AD increases. Three reasons for this are called Pigou's wealth effect, Keynes's interest-rate effect, and Mundell-Fleming's exchange-rate effect.

As the price level for products decreases, people can purchase more with their disposable income. Because of this increase in purchasing power, consumers feel richer, and are able and willing to spend more.
 * Pigou's Wealth Effect**

When price levels are low, consumers use less of their disposable income to make purchases. They tend to save the rest, which in turn drives down the interest rate. A low interest rate drives down the cost of investments; therefore investments increase and aggregate demand increases.
 * Keynes's Interest-Rate Effect**

Keynes's Interest-Rate Effect Law tells us that as price levels decrease, saving increases, and interest rates fall. This is good for people taking out money for mortgages and loans; however, for those investing in the bank, this decreases their return. Therefore, people begin to invest in foreign countries. The real exchange rate for domestic currency depreciates, and net exports increases because it is cheaper for foreigners to buy domestic goods from a country whose currency value has decreased. In turn net exports increase causing aggregate demand to increase. So as the price level drops, interest rates fall, domestic investment in foreign countries increases, the real exchange rate depreciates, net exports increases, and aggregate demand increases.
 * Mundell-Fleming's Exchange-Rate Effect**

[|Article Relating To Aggregate Demand]

[|SHIFT ME BABY ONE MORE TIME]

__C. Aggregate Supply__
Aggregate Supply (AS) is the measure of the amount of goods and services produced within an economy at a given price level. Aggregate supply and price level have a positive relationship, when prices begin to rise, it is generally a sign for businesses to increase production to meet a higher level of aggregate demand. When demand increase in an economy, it should be followed by an expansion of aggregate supply.


 * Aggregate supply** is determined by the **supply side performance of the economy**. It reflects the **productive capacity** of the economy and the **costs of production**.

1. Determinants of Aggregate Supply:

 * Any rightward shifts in the production possibilities curve translate into rightward shifts in the aggregate supply curve.
 * An increase in the supply of national resources will cause a decrease in per unit production costs. A decrease in production costs per unit will cause an rightward shift in the aggregate supply curve. Domestic or national resources include land, labor, capital, and entrepreneurial ability.
 * Prices of imported resources:** If the price of an imported resource falls, then there will be an increase in aggregate supply, with a rightward shift in the AS curve.


 * American Exchange rate:** Changes in the U.S. exchange rate affect the price of imported resources. When the value of the dollar increases and the price of foreign currency falls Americans are able to buy more foreign currency with each U.S. dollar. American producers are then able to buy more foreign resources with each dollar, therefore causing a rightward shift in the aggregate supply curve.


 * Market Power:** Market power is the ability of a firm to set a price above the price that would occur competitively. For example, OPEC controlled most of the oil industry therefore, an increase in the price of oil, will cause the aggregate supply curve to shift leftward because of an increase in per unit production costs.


 * Changes in productivity:** Productivity = real output / input When productivity is increased, there is an increase in the amount of good produced without an increase in the cost of production, resulting in a shift in the AS curve.


 * Changes in legal-institutional environment:** Taxes can be considered costs by a business. When the government increases taxes, per unit production costs also rise. It is usually costly for a business to follow government regulations. An increase in government regulations or taxes increase per unit production costs and causes a shift in the aggregate supply.

The **labor force** is defined as the number of people employed plus the number unemployed but seeking work. The **nonlabor force** includes those who are not looking for work, those who are institutionalised such as in prisons or psychiatric wards, stay-at home spouses, children, and those serving in the military. The **unemployment** **level** is defined as the labor force minus the number of people currently employed. The **unemployment rate** is defined as the level of unemployment divided by the labor force. The **employment rate** is defined as the number of people currently employed divided by the adult population. Self-employed people are counted as employed. Changes in the labor force are due to long run variables such as natural population growth, net immigration, new entrants, and retirements from the labor force. Changes in unemployment depend on: inflows made up of non-employed people starting to look for jobs and of employed people who lose their jobs and look for new ones; and outflows of people who find new employment and of people who stop looking for employment.
 * 2.** **Alternative aggregate supply curve shapes**
 * 1) Short run aggregate supply (SRAS) - Aggregate supply during a short period of time. Includes changes in firms such as a change in the amount of labor used but not capital. For examples building a new factory. This form of aggregate supply shows what happens to the economy under the most slack, when resources are underused. An Upward shift in SRAS will generally cause output to increase but not price. The SRAS curve is horizontal. The concept is that wages, the price of labor, doesn't change in the short run.
 * 2) Long run aggregate supply (LRAS) - In the long run, only capital, labor, and technology affect the aggregate supply curve of the macroeconomic model. At this point everything in the economy is assumed to be used optimally. In most situations, the LRAS is viewed as a static curve because it shifts the least of the three types of aggregate supply. The LRAS is shown as a vertical line, reflecting the belief that any changes in aggregate demand (AD) will have temporary changes on the economy's total output.
 * 3) Medium run aggregate supply (MRAS) - As an interim between SRAS and LRAS, the MRAS form slopes upward and reflects when capital as well as labor can change. When graphing an aggregate supply and demand model, the MRAS is generally graphed after aggregate demand (AD), SRAS, and LRAS have been graphed, and then placed so that the equilibria occur at the same point. The MRAS curve is affected by capital, labor, technology, and wage rate.
 * 3.** **Effects of the labor market on aggregate supply**

Any changes of the labor market directly affect the aggregate supply curve. An increase in employement, will lead to an increase in production, and a rightward shift on the aggregate supply curve. An increase in the unemployment rate will cause production to decrease and a leftward shift on the aggregaet supply curve.

When productivity gains drive up wages in one industry or occupation, it is anticipated that workers will be drawn from other industries and occupations, thereby returning relative wages to their initial level. If productivity increases at the //national// level, however, the equivalent effect would require that workers be drawn from other countries. But, as Canada restricts the number of immigrants, this effect will be much less important for national wage levels than it was for industry wage levels. Also, a productivity gain at the national level is less likely to lead to a reduction in output prices than is an equivalent gain at the industry level. When output increases in an industry, everything else being constant, the industry may have to lower prices in order to sell that increase. When output increases in the nation as a whole, however, all workers will have higher incomes and those incomes may be used to purchase the increased output. In a sense, the increased output “creates” the increased demand to purchase that output. Prices need not fall. And if prices //do// fall, the “real” incomes of all workers will increase. That is, even if observed (or nominal) wages do not change, workers will be able to buy more goods and services with their incomes. They will be better off in a “real” sense. Thus, an economy-wide increase in productivity could cause an increase in the welfare of workers, not through an increase in observed money wages, but through a decrease in average prices. ==**[|Aggregate Supply] [|Aggregate Supply practice question]**==
 * 4.** **How wages are determined**

**__D. Macroeconomic Equilibrium__**
The supply curve slopes upward because an increase in prices induces the producers to supply more goods and services. The following explain why there is an inverse reationship between price and GDP in the AD model: - real balances effect- produced by change in price level; it is the tendency for an increase in the price level to lower the purchasing power of existing financial assets, which decreases total spending - interest rate effect- it is the tendency for an increase in the price level to increase demand for money, raise interest rates, and reduce total spending. Basically when the price increases, goods and services requite more dollars so people sell off bonds, driving up interest rates. - foreign purchases effect (exchange rate effect)- the inverse relationship between the net exports of an economy and it's price level relative to foreign price levels. (When interest rates increase, it attracts foreign investors, allowing the dollar to appreciate.)
 * 1. Aggregate demand and aggregate supply together**: the AD-AS model allows for insights on economic growth, inflation, and unemployment.

This video is related to supply and demand so I figured I would add it. It may or may not be very useful though. http://www.youtube.com/watch?v=qEDgejfDAjw


 * 2. Short-run equilibrium:** Equilibrium price and quantity are found where the aggregate demand and aggregate supply curves meet.

An increase in aggregate demand would increase both GDP and the price level. EX: Foreigners increase their spending. There is an increase in AD because whenever their is an increase in spending; there is an increase in exports which leads to an increase in real GDP. (The equilibrium price increases, as well as the level of GDP.)

A decrease in AD may or may not have a similar opposite effect because the prices may be inflexible at the time for various reasons. EX: Consumers decrease their spending because they predict that there will be a recession in the future. When there is a decrease in spending, there is a decrease in demand for goods and services. This leads to a decrease in output and the supply of products. (The equilbrium price has decreased and so has the equilibrium quantity of GDP.)

An increase in aggregate supply inccreases real GDP, reduces employment, and lowers prices. EX: There are technological advances. New technology allows for increased output and a fall in prices. (The equilibrium point has shifted to the right and then down which is what consumers like because there are a lot of goods and services and the prices are low.) A decrease in AS decreases economic growth, increases unemployment, and raises the prices. EX: An increase in inflation has caused workers to demand higher wages. When workers demand higher wages, companies cannot afford to hire as many people. Therefore AS falls back and reduces output. (The equilibrium price has increased while equilibrium GDP has decreased.)

This link goes straight to an amazing and in-depth explanation of equilbrium, both long-run and short-run. It gives a great example that may help to refresh your memory on the topic. http://www.raybromley.com/notes/ADASequiMove2.html

Supply shocks change the price of a good or service suddenly. They are often due to changes in the supply of that good or service. When the supply decreases there will be an increase in prices and the AS curve will move back to the left, reducing total output as well. This negative supply shock can cause stagflation (combination of inflation, little to no output, rising unemployment, and recession). There is an opposite effect when the supply increases. Prices decrease and the AS curve shifts to the right. This is caused by anything that makes a nation produce goods and services more efficiently. Demand shocks are similar to supply shocks. A positive demand shock results in increases in GDP and price level while a negative demand shock causes a decreases in both areas.
 * 3. Effects of aggregate supply and aggregate demand shocks**


 * 4. Long-run equilibrium and production possibilities curve**

Refresher: The LRAS curve is a vertical line that shows the amount of goods and services a nation can produce. In the long-run, a nation wants as much output as possible at a certain price, but there is only so much you can produce before the price makes it change. Note: Price matters in the short-run more than in the long-run. Also remember that the PPC is a graph comparing the maximum outputs of two goods or servicees that a nation gan produce. If a nation wants to produce more of one thing, they must produce less of the other. This PPC shows that a nation is producing food and computers. When it is producing 11 units of food it is producing 0 computers. If the nation was at a point on the inside of the curve, then they are not producing goods and services very efficiently, and when they are at a point outside of the curve, they have gained new technological advances or something of the sort that has allowed them to become more efficient.


 * 5. Analysis of the economy moving from the short-run to the long-run equilibrium**

If there was an increase in AD starting at full employment then the AD curve would shift right. If the economy was to move to the long-run equilbrium, then the SRAS curve would move back as AD moves to the right in order to adjust wages. There will only be a change in the price level. There are output changes at the LRAS curve but not at the SRAS curve. Wages will continue to rise or fall, depending on prices. If prices go up then workers demand higher pay so that they can afford things. Higher prices eventually leads to a decline in employment (rise in unemployment) because businesses cannot afford to have as many employees when they have to pay each one more money. This link goes to a video that may serve as a bit of comic relief for all of the economic information you have read so far. (Maybe Blaine can pick up a few jokes from this guy!!) http://www.youtube.com/watch?v=YgB6mFmYEcM&feature=related

Sources: http://economics.about.com/od/aggregatedemandsupply/ss/aggregate_3.htm http://www.mhhe.com/economics/mcconnell/student/olc/outline11.htm http://www.whitenova.com/thinkEconomics/adas.html

__E. Fiscal Policy__
The government policy that infulences the direction of the economy by government spending and taxation.

- In an expansionary fiscal policy to stimulate demand, government spending increases. When government spending increases, GDP increases.
 * 1. Effects of change in government spending**

- In a contractionary policy government spending decreases. When government spending decreases, GDP decreases.

- Tax Decrease = increase income ---> consumption increases ---> increases amount demanded With more money in the economy and a decrease in taxes, consumers will have more money and are willing to spend more, which in turn causes a higher demand for goods and services.
 * 2. Effects of change in taxation**

- Tax Increase = decrese income ---> consumption decreses ---> decreses amount demanded With less money in the economy and an increase in taxes, consumers will have less money and will not want to spend, which in turn will cause a decrese in demands for goods and services.



- Programs that automatically expand the fiscal policy during a recession and contract it during booms. - They are built into the government but do not need government action or authorization which helps ensure that necessary adjustments can happen quickly
 * 3. Automatic Stabilizers**

Example: 1. Unemployment Insurance - government spends more when unemployment rate is high. 2. Tax Code - taxes are almost proportional to wages and profits; the amount of taxes collected is higher during a boom and lower during a recession

When taxes are greatly cut, spending increases and stimulated economic activity in the short run. In the long run, however, a cut in taxes raises output less than the amount of the tax cut itself.
 * 4. Short run effects on output and the price level**

In the short run there will be an increase in GDP and in price levels, but over time there will be higher prices but no change in GDP.

Sources used: http://business.baylor.edu/Tom_Kelly/2307ch12.htm http://www.econlib.org/library/Enc/FiscalPolicy.html Economics Demystified, August Swanenberg, 2005 McGraw Hill
 * I didn't feel the need to clog up my section with graphs and tables that no one can understand. Points for me!! ;o)