Unit III. National Income and Price Determination


And you can add economics as applied sociology. with a man with a Top Hat, a white mustaushe, and a cane.
A) Agregate Demand
Price Level versus GDP graph
Price Level versus GDP graph

Aggregate demand is the demand for the gross domestic product (GDP) of a country, and is represented by this formula:

Aggregate Demand (AD) = C + I + G + (X-M) C = Consumers' expenditures on goods and services. I = Investment spending by companies on capital goods. G = Government expenditures on publicly provided goods and services. X = Exports of goods and services. M = Imports of goods and services.

1. Determinates
A few of the more notable determinants that tend to stand out in the study of macroeconomics and the analysis of the aggregate marketare:
  • Interest Rates: Interest rates affect the cost of borrowing and thus both consumption and investment expenditures. Interest rates are a component of investment-driven business cycles and play a key role in monetary policy.
  • Federal Deficit: The federal deficit is comprised of government purchases, which is one of the four basic expenditures, and taxes, which affects the amount of disposable income available for consumption. Changes in the federal deficit commonly result from the use of fiscal policy.
  • Expectations: Household and business expectations of future business-cycle conditions, especially inflation and unemployment, affect consumption and investment expenditures.
  • Money Supply: The quantity of moneycirculating in the economy directly affects the buying capabilities of all four sectors and thus affects all four expenditure categories--consumption, investment, government purchases, and net exports. Control of the money supply is the key to monetary policy.
  • Consumer Confidence: The degree of household sector optimism or pessimism affects current consumption expenditures.
2. Multiplier and Crowding Out

external image d9bc48d2d02bff6f4aced0b842ef6846.jpgBad Example of the money Multiplier.

In monetary macroeconomics and banking, the money multiplier measures how much the money supply increases in response to a change in the monetary base.
The multiplier may vary across countries, and will also vary depending on what measures of money are considered. For example, consider M2 as a measure of the U.S. money supply, and M0 as a measure of the U.S. monetary base. If a $1 increase in M0 by the Federal Reserve causes M2 to increase by $10, then the money multiplier is 10.

Theory that heavy borrowing by a government (which can pay any interest rate) soaks up the available credit, leaving little for the private sector at affordable interest rates. Opponents of this theory point out that new sources of credit emerge at every stage of an interest rate increase.
B) Aggregate Supply
In economics, aggregate supply is the total supply of goods and services that firms in a national economy plan on selling during a specific time period. It is the total amount of goods and services that firms are willing to sell at a given price level in an economy.

1. Short run aggregate supply (SRAS) — Within the time frame during which firms can change the amount of labor used but not capital (such as building new factories). This form demonstrates what happens to the economy under the most slack, when resources are underused. Upward shifts in SRAS generally increase output (y) but don't increase price (P). The SRAS curve is nearly perfectly horizontal. The concept is that wages (price of labor) don't change over the short run.
external image cartoon.jpgThis is likely to have been caused by a change is SRAS.

2. Long run aggregate supply (LRAS) — Over the long run, only capital, labor, and technology affect the LRAS in the macroeconomic model because at this point everything in the economy is assumed to be used optimally. In most situations, the LRAS is viewed as static because it shifts the slowest of the three. The LRAS is shown as perfectly vertical, reflecting economists' belief that changes in aggregate demand (AD) have an only temporary change on the economy's total output.

3. Stickey wages
The tendency for wages to remain high during recessions.
If wages were not sticky, the price of labour would fall as with other production costs and there would be far less unemployment. This is what happened in depressions for many years. And this explains their short duration.\

Stickey wages can also work the other way and not rise during expansion this is when this hapens.
Flexible wages are not sticky
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C. Macroeconomic Equilibrium

Macroeconomic equilibrium for an economy in the short run is established when aggregate demandintersects with short-run aggregate supply. This is shown in the diagram below
external image adas1.gif
Pe is the current price level and Ye is real gdp.

What you see above is the short run. The long run has vertical LRAS curve and the equilibrium must fall along this line thus producing at full employment.
Actual employmentis where output actually falls. Full employment is at the LRAS.

Economic fluctuations are the waves in the Business cycle as seen below (Its just the boom and bust cycle, don't fear it!)
external image business-cycle-graph-better.jpg

Hopefully this will raise the supply of laughter.
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