Aggregate supply

Aggregate supply

• the level of real GDP (GDP R) that firms will produce at each price level(PL)

Long-run: period of time where input prices are completely flexible and adjust to changes in the price-level.

• in the long run the level of real GDP supplied is independent of the price level

Short-run: period of time where input prices are sticky and do not adjust to changes in the price level

• in the short-run, the level of REAL GDP supplied is directly related to the price level

-Long-run aggregate supply (LRAS)

• the long-run aggregate supply or LRAS marks the level of full employment in the economy(analogous to PPC)

• because input prices are completely flexible in the long-run, changes in price-level do not change firms' real profits and therefore do not change firms' level of output. This means that the LRAS is vertical at the economy's level of full employment.

- Short run aggregate supply(SRAS) 

• because input prices are sticky in the short run, the SRAS is upward sloping.

- Changes in SRAS 

• an increase in SRAS IS SEEN AS A SHIFT TO THE RIGHT. SRAS->

• a decrease in SRAS is seen as a shift to the left. SRAS<-

• The key to understanding shifts in SRAS  is per unit cost of production

•Per unit production cost= total input cost/ total output

-Determinants of SRAS( all of the following affect unit of production)

•input prices

•productivity

• legal-institutional environment

-Input prices

• domestic resources prices

~ wages (75% of all business costs)

~ cost of capital

~ raw materials(commodity prices)

• Foreign resources prices

~ strong$ = lower foreign resource prices

~ weak$= higher foreign resources prices

•market power

~monopolies and cartels that control resources control the price of those resources

• increase in resource prices= SRAS <-

•decrease in resource prices= SRAS->

-Productivity

• productivity= total output/ total inputs

• more productivity = lower unit production cost=SRAS->

•lower productivity = higher unit production cost=SRAS<-

- Legal-Institutional Environment

• taxes and Subsidies

~ taxes ($ to gov't) on business increase per unit production cost= SRAS<-

~ subsidies($ from gov't) to business reduce per unit production cost= SRAS->

• Government regulation

~ government regulation creates a cost of compliance=SRAS<-

~ Deregulation reduces compliance costs= SRAS->

Aggregate Demand

1. Aggregate Demand - Shows amount of real GDP that the private, public and foreign a sector collectively desire to purchase at each possible price level
2. The relationship between price level and level of real GDP is inverse

The Reason AD is Downward Sloping

1. Real-Balances Effect
1. When price level is high, households and businesses can not afford to purchase as much output
2. When price level is low, households and businesses can afford to purchase more output 
2. Interest-Rate Effect
1. A higher price level increases interest rate, which tends to discourage investment
2. A lower price level decreases interest rate, which tends to encourage investment 
3. Foreign Purchases Effect
1. Higher price level increases demand for relatively cheaper imports
2. Lower price level increases foreign demand for cheaper US exports 
4. Shifts in Aggregate Demand
5. There are two parts to a shift in AD:
1. Change in C, Ig, G and Xn
2. Multiplier effect that produces greater change than original change in the 4 components
6. Increases in AD go right
7. Decreases go left
8. Determinants of AD

Consumption

1. Household spending is affected by:
1. Consumer Wealth
1. More wealth, more spending (AD increases)
2. Less wealth, less spending (AD decreases)

1. Consumer Expectations
1. Positive expectations - more spending 
2. Negative expectations - less spending 

1. Household Indebtedness 
1. Less debt, more spending 
2. More debt, less spending 

1. Taxes
1. Less taxes, more spending
2. More taxes, less spending 

1. Gross Private Investment

1. Investment spending is sensitive to:
1. The Real Interest Rate
1. Lower interest rate, more investment (AD increases)
2. Higher interest rate, less investment (AD decreases)

1. Expected Returns
1. Higher expected returns, more investment
2. Lower expected returns, less investment 

1. Expected returns are influenced by: 

1. Expectations of future profitability
2. Technology
3. Degree of excess capacity (Existing Stock of Capital)
4. Business Taxes

Government Spending

1. More government spending, AD increases
2. Less government spending, AD decreases

Net Exports

1. Net Exports are sensitive to:
1. Exchange Rates (International value of $)
1. Strong $ = More imports and fewer exports (AD decreases)
2. Weak $ = Fewer imports and more exports (AD increases) 

1. Relative Income
1. Strong foreign economies = more exports, AD increases
2. Weak foreign economies = less exports, AD decreases

Unemployment

Unemployment - The percentage of people who don't have a job but are part of the labor force.
Labor Force - The number of people in a country that are classified as either employed or unemployed.

How to Calculate Unemployment Rate
(number of unemployed / (number of unemployed + number of employed)) x 100
Labor Force : number of unemployed + number of employed x 100

Those Who Are Not Considered to Be in the Labor Force

• Kids
• Retired people
• Military personnel
• Mentally insane
• Incarcerated
• Full time student
• Stay at home parents
• Discouraged workers (looking hard for work but can't find it)

What is full employment?

• Occurs when there is no cyclical unemployment present in the economy.
• Natural rate of unemployment (NRU) is achieved when labor market are imbalanced.  4-5%

How to get NRU?

• Structural unemployment+ frictional unemployment
• We don't count homeless people, based on last job or if you file information

Why is unemployment good?

• Less pressure to raise wages
• More workers available for future expansions

Why is unemployment bad?

• Not enough consumption(GDP)
• Too much poverty
• Too much government assistance is needed

Types of Unemployment

• Frictional - You are between jobs because you chose new opportunities, choices, lifestyle and education levels (this is voluntary)
• Seasonal - People are waiting for the right season to conduct trade

• Cyclical - Associated with downturns in the business cycle
• Structural - Associated with lack of skills (illiteracy, or perhaps a shift in location) or declining industry or change in technology)

Okun's Law - For every one percent of unemployment above NRU causes a 2% decline in real GDP.

• Ex. NRU = 3.5%, we give up 7% of real GDP

Inflations

 Inflation

 A rise in the general level of prices Standard Inflation Rate : 2-3%
 Measuring Inflation

• A. Inflation Rate - Measures percentage increase in price level over time
• ~ Key indicator of economy's strength

Deflation - Decline in general price level
Disinflation - Occurs when inflation rate itself declined
Consumer Price Index (CPI) - Measures inflation by tracking the yearly price of a fixed basket of consumer goods and services
Indicates changes in the price level and cost of living
 Solving Inflation Problems

• Finding inflation rate using market basket data -

((current year market basket value - base year market basket value) / base year market basket value) x 100

• Finding inflation rate using index prices-

((current year price index - base year price index) / base year price index) x 100

• Estimating inflation rate using the rule of 70-

 Rule of 70: Used to calculate the number of years it will take for the price level to double at any given rate of inflation
Years needed to double inflation = 70 / annual inflation rate
Determining real wages
(Nominal wages / price level) x 100
Finding real interest rate
 Real interest rate = nominal interest rate - inflation premium

• Cost of borrowing or lending money that is adjusted for expected inflation (always expressed as percentage)

Nominal Interest Rate = 

• did not adjust the cost of borrowing or lending money

Causes of Inflation

•  Demand-Pull Inflation - Caused by an excess of demand over output that pulls prices upward
• Cost-Push Inflation - Caused by a rise in per unit production cost due to increasing resource cost

 Effects of Inflation

• Anticipated - Ex. In a year, we're gonna lay off people. You see it coming.

• Unanticipated - Ex. Just fired abruptly. It hits you like a freight train.

Hurt by Inflation

•  People on Fixed Income - Social security, etc.
• Savers - People who save money
•  Lenders/Creditors

Helped by Inflation

•  Borrowers, because their debt would be repaid with cheaper dollars than those that were loaned out

• Fixed Contracts - Rate cannot change

Nominal and Real GDP

Nominal GDP-

• A value of output produced in current prices 
• Formula: P x Q =
• Increase from year to year if either output or price increase 

Real GDP-

• The value of output produced in constant or base year prices
• Adjusted for inflation
• Formula: Also P x Q=
• Can increase from year to year only if output increases

Price Index-

• Measures inflation by tracking changes in the price of a market basket of goods compared to the base year
• Formula: price of market basket of goods in current year / price of market basket of goods in base year x 100 =

GDP Deflator-

• Also a price index used to adjust from nominal to real GDP 
• In base year, GDP Deflator will equal 100 
• For years after the base year, GDP deflator will be greater than 100 
• For years before the base year, GDP Deflator will be less than 100 
• Formula: nominal GDP / real GDP x 100 =

 Inflation Rate Formula-

• ((New GDP deflator - old GDP deflator) / (old GDP deflator)) x 100=

Expenditure and income approach

Expenditure Approach-

• Add up market value of all domestic expenditures made on final goods and services in a single year
• C + Ig + G + Xn = GDP

Budget Formula-

• Government purchases of goods/services + government transferred payments - government tax and fee collection=
• If the budget is a positive number, it is deficit.
• If the budget is a negative number, it is a surplus.

Trade Formula

• Exports - Imports=

How to Find GNP

• GDP + Net Foreign Factor Payment=

NNP (Net National Product)

• GNP - depreciation=

NDP (Net Domestic Product)

• GDP - depreciation National Income (Either Formula Will Work)
  1. GDP - Indirect business taxes - depreciation - net foreign factor payment =
  2. Compensation of employees + proprietor's income + rental income + interest income + corporate profits=

Disposable Personal Income

• National Income - personal household taxes + govt transfer payment=

GDP

GDP(Gross Domestic Product)-Total dollar value of all final goods and services produced within a country borders within a given year. 


GNP(Gross National Product)- It is the total value of all final goods and services produced by Americans in a year.

GDP Formula: C + Ig + G + Xn

• C- Consumption

1. 67% to the economy
2. Purchasing finished goods and services

• Ig- Gross private domestic investments

1. Factory equipment maintenance 
2. New factory equipment
3. New construction housing
4. Unsold inventory of products built in a year

• G- Government spending

1. Xn-Net exports
2. Exports- imports= 

Excluded from GDP

• Used on secondhand goods
• Intermediate goods- Goods and services that are purchased for resale or for further processing or manufacturing avoid multiple or double counting
• Non-market activity- illegal drugs, any unpaid work, doing own repairs job at home, prostitution, babysitting, and growing own vegetables in the backyard.
• Financial transaction
• Gifts on transfer payments

1. Private- Produces no outputs, transfer funds from one private individual to another. 
2. Public- recipients contributes nothing to the current output or productions

• Household - A person or a group of people that share income
• Government 
• Firm (Businesses) - An organization that produces goods and services for sale
• Resources/Factor Market - A place where households sell resources and businesses buy resources
• Product Market - A places where goods and services are produced by businesses and are bought and sold by the household