College Principles ofPhysics Economics ChapterSupply–Aggregate # Chapter Title Chapter 24 The Aggregate Demand Model PowerPoint Image Slideshow The housing market Between 2000 and 2006, a housing bubble was formed At the peak of the housing bubble, many people across the country were able to secure the loans necessary to build new houses Banks gave loans to many homeowners who did not have enough income to qualify In late 2006/early 2007, the housing bubble burst, causing prices to crash and foreclosures to mount The housing market From the early 1990s up through 2005, the number of new single family houses sold rose steadily In 2006, the number dropped dramatically and this dramatic decline continued through 2011 In 2012, the number sold rose a bit over previous years, but it was still lower than the number of new houses sold in 1990 4 of 37 MAJOR MARKETS IN THE ECONOMY Product Market: The market in which goods and services are exchanged and in which the equilibrium level of GDP is determined Money Market: The market in which financial instruments (money, bonds, and stocks) are exchanged and in which the equilibrium rate of interest is determined 5 of 37 THE AGGREGATE DEMAND Aggregate Demand (AD): The relationship between Real GDP and the general level of price Each point on the AD shows a pair of income and price, which brings both product and money markets to equilibrium THE AGGREGATE DEMAND Aggregate Demand slopes down, showing that, as the price level rises, the amount of total spending on goods and services declines Aggregate Supply Aggregate Supply (AS) shows the relationship between total output supplied by all firms and the general price level Aggregate Supply traces out the price and output decisions of all the markets and firms Short-run Aggregate Supply The shape of AS depends on productive capacity of the economy AS is inverted L-shaped At low levels of output with high unemployment, AS is fairly flat As the economy approaches full capacity, AS gains a positive slope At full capacity, the AS becomes nearly vertical 9 of 37 AGGREGATE SUPPLY AS slopes up because rising prices induce firms to produce more and earn higher profits The “potential” GDP line shows the maximum that the economy can produce with full employment of workers and physical capital In the longrun AS becomes a vertical line Aggregate Supply Aggregate equilibrium AD = SRAS = LRAS at potential GDP (Y0) Aggregate equilibrium Short-run equilibrium is achieved at less than full-employment 13 of 37 SHIFT IN AGGREGATE SUPPLY a) The rise in productivity causes the SRAS curve to shift to the right Increases in AS, lead to a greater level of output and a lower level of price b) Rising input prices means a lower quantity will be produced so AS shift to the left from AS0 to AS1 Decrease in AS results in reduced output, but a higher price SHIFT IN AGGREGATE SUPPLY a) Improvement in consumer or business confidence shifts AD to the right, getting the economy closer to potential GDP An increase in government spending or a cut in taxes also shifts AD to the right b) Worsening consumer or business confidence shifts AD to the left, getting the economy farther from potential GDP A decrease in government spending or higher taxes also shifts AD to the left 15 of 37 SHIFT IN AGGREGATE DEMAND SHIFT IN AGGREGATE DEMAND SHIFT IN AGGREGATE DEMAND Whether the economy is in a recession is illustrated in the AD-AS model by how close the equilibrium is to the potential GDP In this example, an increase in AD can get the economy closer to full employment Effect of aggregate demand policy An increase in AD when the economy is operating at low levels of output is likely to result in an increase in output with a small increase in the price level As the economy approaches full-employment, firms respond to further increases in AD by raising prices to cover higher production costs  ... equilibrium rate of interest is determined 5 of 37 THE AGGREGATE DEMAND Aggregate Demand (AD): The relationship between Real GDP and the general level of price Each point on the AD shows a pair of income... output decisions of all the markets and firms Short-run Aggregate Supply The shape of AS depends on productive capacity of the economy AS is inverted L-shaped At low levels of output with high... the number of new houses sold in 1990 4 of 37 MAJOR MARKETS IN THE ECONOMY Product Market: The market in which goods and services are exchanged and in which the equilibrium level of GDP is determined