[MUSIC] So that, in order to understand what's going on in the economy and what takes it where it goes. We're going to turn this sort of static picture into a dynamic picture, where we start to move these curves around and see what happens to the economy. And then, in a few minutes, we'll be talking about what causes them to move. So let's just start out by thinking of aggregate demand as what, the way we defined it earlier, which is C + I plus G, plus X minus M. This was all the sources of spending that we had talked about in the circular flow diagram. So, if aggregate demand is all of those things, let's imagine that one of those, The C, the I, the G or the X minus M, changes, alright? And they change in a positive way so they increase. What we would, the way we would illustrate that would be to draw this aggregate demand curve. A little farther out to the right. Okay? So we shift it right and you can see the arrow showing the direction of the movement. You can see that arrow demand has increased relative to where it was before. Okay? Now if you look at those factors consumer spending and investment spending, government spending, net exports it's easy to imagine that they're going to move around. It's easy to imagine that one of them will have a sudden increase or a sudden decrease. So this happens all the time. So we've drawn this curve out to the right and I would encourage you to take a piece of paper and be drawing this while I'm talking because it will help you a lot to just, just to visualize it and remember the way it goes. So we've shifted aggregate demand to the right. And so, if we draw a. a new equilibrium between aggregate supply and aggregate demand, because the old one is no longer any good. Alright? We draw a new equilibrium. We can see that what happens is that the GDP of the country increases. Okay? So we're getting growth. Alright, now if it increases a lot, we get more growth. So if you think about the business cycle, we drew, we're increasing real GDP. It's going up, alright? And then you can see if you look at the vertical axis, and draw our new equilibrium. You can see that inflation has risen, okay? So we've got more GDP, and we've got more inflation, just like we predicted along the business cycle in our, in our conversation a little earlier. Now if you think additionally about this horizontal axis, where you've got GDP, and you just think intuitively about what is the relationship between unemployment and GDP. It's easy for you to imagine that when we go to the right on this horizontal axis, to higher levels of GDP, unemployment will be going down right? So, GDkip, GDP gets bigger, unemployment gets smaller. That's, that would, that's very very intuitive right? More production, more jobs, okay? If we go the left on this horizontal axis, you can imagine that unemployment would be going up because we're producing less. So companies need fewer workers to produce it, they lay off workers, or they won't create new jobs, unemployment will go up. Okay? So just as we think about all this, I want you to remember that as we move to the right or to the left on the horizontal axis unemployment will be going down or up, as GDP moves. As we move up and down on the vertical axis, inflation will be going up or down. Okay? In response to the shifts in aggregate demand or aggregate supply. Okay. So just think about all this and again, I encourage you to draw it so you can follow what we're talking about. So we've shifted average demand out to the right and we've seen that as a result, we get more GDP, less unemployment, and higher inflation. Okay? Again, just like we predicted on the distant cycle that we drew a little bit earlier, unemployment inflation moving opposite directions. Okay? As GDP moves. Now let's imagine that instead of one of these the C, I, or G or the X minus M increasing, lets imagine that something happens to make it decrease. Something like what we talked about earlier. There's a financial crisis and, and people are afraid and they start to save. This could cause the aggregate demand curve to shift inward to the left if one of these factors changes. So we move this curve inward to the left and relative to the curve where we were before. We now have a new equilibrium. Okay? Take this new aggregate demand curve, this new low aggregate demand curve. Find where it intersects, the supply curve, the aggregate supply curve. And we will see that we now have less GDP. Okay? So GDP has declined, which means that unemployment has risen, right? And if we make the, find the point of intersection with the vertical axis, we see that inflation has gone down, okay? So aggregate demand has decreased. GDP of course has decreased. So we're going down in the business cycle. And what's happening additionally is that inflation is going down and unemployment is going up, relative to where they were before. Okay, so again you see this, inverse relationship between the two, between inflation and unemployment as aggregate demand moves. Alright? So this is what happens if aggregate demand moves. And often, it's aggregate demand that drives our macro economy. You look at those things, C, I, G, X minus M. We've imagined that they can all be moving all the time. So often these are the major factors driving our economy. And that's why, often, we see unemployment and inflation moving in opposite directions from each other like we observed earlier with the US economy. But there's another curve in this picture, it's not just aggregate demand, there's an aggregate supply curve. And now, let's think for a little bit, and again I'd encourage you to draw this. Let's think about what happens when aggregate supply moves. Okay? Let's take the existing aggregate supply curve, and let's make a new one just a little bit to the right of it. Okay? So we're shifting it outwards to the right. This is an increase in aggregate supply. Even though it looks like it's moving closer to the axis, looks like it might be going down, this is an increase in aggregate supply. Companies are willing to produce more than they were willing to produce before. Okay? And at lower prices. So if we now find an intersection between this new aggregate supply curve and our first aggregate demand curve and I hope you can figure out which one it was, if we find the intersection between this new aggregate supply curve and our original aggregate demand curve, you get a surprise, okay? You find that GDP has increased, that's not surprising, as GDP increases, unemployment goes down; that's not surprising okay? We've seen that before. So we've got more GDP, less unemployment But look on the vertical axis what happens to inflation. It also goes down. Okay? So you can see that relative to where we were before, this economy now has less inflation and less unemployment. Alright? That's a pretty good situation, isn't it? Usually we have some good news and some bad news. Right now we've got all good news. Less unemployment, less inflation, more GDP. Alright? This is what happens when aggregate supply moves to the right and occasionally it actually does. So let's explore the other possibility which is that aggregate supply shifts inward to the left. So go back to your original aggregate supply curve in the center and move it upward to the left. We call this a decrease in aggregate supply, even though it looks like it's moving up, what's really happening here is that firms are willing to produce less at the same prices as before. Okay? So, aggregate supply has gone left and now let's explore this new equilibrium. Find the point where your new aggregate supply curve intersects with the original aggregate demand curve, al right? And we'll see that we have less GDP. GDP has declined. Now we know that if GDP declines, unemployment goes, up, right? So we have less GDP, more unemployment, al right? And now let's see what's happened to inflation. Find the intersection point between that, this new aggregate supply curve and the original aggregate demand curve and you find to your surprise that inflation has gone up. So all the news here is bad. Aggregate supply shifts to the left, GDP goes down, unemployment goes up, inflation goes up. This is a situation that we refer to as stagflation, it doesn't happen very often. The proof that it doesn't happen very often is that we can probably remember a specific time when this was occurring. I remember the oil price shocks of the '70's. The 70s and the beginning of the 80s. Situations of stagflation where unemployment was going up GDP was falling or stagnate and inflation was rising. We had a little episode of stagflation just this just before this financial crisis broke in 2008. We had world commodity prices, food prices and petroleum prices going up. And we were experiencing unemployment rising unemployment and rising inflation. So stagflation doesn't happen very often, but when it does we remember it because it's the worst of all possible worlds. [MUSIC]
