This is the first of the three courses part of the Globalization, Economic Growth and Stability Specialization. This course will employ a non-technical approach to analyze how governments use policy to influence a country's economy. Upon completing the course you should be able to discuss national debts and deficits, examine fiscal and monetary policy and their appropriateness to the situation of an economy, and anticipate the results of fiscal and monetary policies and structural reform on a country. These concepts will give you the tools to develop your own position in many current economic debates, such as fiscal stimulus vs. austerity, the merits of quantitative easing, the need for higher interest rates or the future growth path of many modern economies.
Aggregate Supply and Aggregate Demand II
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Do curso por IE Business School
Understanding economic policymaking
616 classificações
IE Business School
616 classificações
Curso 1 de 3 em Specialization Globalization, Economic Growth and Stability
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Macroeconomy Overview
We are surrounded by news and commentary on the macroeconomy. To understand it, we need to grasp the meaning of GDP, inflation and unemployment and see what their “normal” levels are and how they relate to one another. Though these levels and relationships are far from mechanical, they provide an essential foundation to understanding what governments are doing in a macroeconomy.
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Gayle AllardProfessor
Economics
[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]
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