macro-demand and supply models

7/31/2019 Macro-Demand and Supply Models

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MACRO-DEMAND AND

SUPPLY MODELSExplorations in Demand and Supply Analysisin the Macro-level



Equilibrium at Full Employment

• Let us revisit the AS-AD Model• On the x-axis of the model is Real-output

• Real output is simply the goods and services produced in youreconomy

• Real-output then is synonymous to GDP (remember definition ofGDP?), so in the AS-AD model, the x-axis is represented by RealGDP.

• On the y-axis is Price-level

• Since the goods and services being considered is of all sorts, they

in a sense become “anonymous”

• We now satisfy ourselves, by fiction, that when we buy thesegoods, we buy them with “price-levels”

• Price-levels can be represented by CPI



AS-AD Model



Aggregate Demand

Why downward-sloping?

• When “everything” is expensive,buyers will tend NOT to buy

• When “everything” is cheap, of course, buyers want to buy!

Real-income effect – When pricesgo down, the purchasing power of

consumers “increases” luringthem to spend and vice-versa

Substitution effect – When pricesare high people substitute theactivity of saving for the activity of

present-day consumption and v.v.



Aggregate-Supply

Why upward sloping?

• Higher prices motivate firms toproduce more and v.v.

• As production expands LDMR setsin making production costlier; thisincreasing relative cost istranslated as increases in prices ofgoods and services.



Full-employment and P-GDP

Potential-GDP is that level of output(qty. of goods and services) aneconomy can meet when there isFull-employment.

It is useful to imagine always thatwhen talking about aggregatesupply, it is always tied to Full-employment.



Equilibrium: Where AS Meets AD

When AS meets AD, there isequilibrium; there just enoughquantities of goods thathouseholds want to buy and firms

want to produce.

Equilibrium price-level (prevailingCPI)

Equilibrium GDP (current Real-

GDP)



Equilibrium at Full-employment: A VerySpecial Case

When equilibrium falls at exactly full-employment (that is RGDP=PGDP),then a special case arises.

We call this case, “Equilibrium atFull-employment”.



Other Equilibrium Cases



Example 1



Economics of War

• Wars bring about governmentexpenditure; gov’t buys weapons,uses oil, feeds army, buys uniforms

etc.

• Thus, a war shifts AD to the right

• This shift in turn increases real-output (GDP increases!)

• Ever wondered why every decadesince WWII the US has always beenat war with another nation?



Christmas Economics

Philippine GDP (in Billions of US$) per Qtr (2008-2011)

Q1 – Jan-Mar

Q2 – Apr-Jun

Q3 – Jul-Sep

Q4 – Oct-Dec



Christmas Economics

Why does GDP always increaseduring Q4?

• Christmas induces spending

• OFWs send “pamaskos” (US$)

• Christmas bonuses given tosalaried employees

• AD shifts to the right, R-GDP

increases; but price alsoincreases



Seasonal Employment

Suppose that before the Christmas season,equilibrium is at full-employment. But, sinceit’s Christmas national output increases.

Raised R-GDP means more labourhours, which means more workers.More workers means employment!



Seasonal Employment

• So in the weeks leading to and during the Christmasseason, more people get employed!



Price of Oil Increases

• When price of Oil (a prime commodity) increases, weexperience a domino effect.

• Price of gasoline and diesel, both crude-oil derivatives, increase

• Price of “pamasahe” increases

• Price of logistics/carriage fee increases

• Price of goods delivered via transport (including other primecommodities like rice and flour will also increase)

• Overall price-levels in the economy increases



Price of Oil Increase

• If nominal wage-rate doesn’t change during this time, thenbuying-power of real wages decrease

• People will tend not to buy

Before increases in price-levelAfter increases in price-level



Price of Oil Increase

When there is a general feelingof people not wanting to buy,then,

• AD shifts to the left

• National output decreases



Economic Contraction

The danger of a protracted oil-increase isthat AD will contract, R-GDP will fall

When R-GDP falls, less aggregate-hours are needed, which meansless workers and less jobs and



Economic Contraction

• Every percentage in unemployment is no joking matter

• Philippine labour-force (2010) = 60 718 000

• 1% of labour force = 607 180

• So for every 1% increase in unemployment, you are

talking of 607 180 people loosing jobs!



The Population “Boon or Bane?”



Increasing Population

Generally, an increasing populationmeans an increasing labour-force

More available workers means morecapacity for work

As long as there are jobs or job-potential, AS will expand

When AS expands, national outputincreases!



Have you read this?



Quantity Must Go With Quality

• But it must be remembered that the quantity of the labour-force is not the only factor to be considered

• AS will even shift further to the right if our people are

made even more productive

• People are more productive when they engage in skilledand specialised labour

• Unskilled labour – work/job people can engage in without or withminimal training

• Skilled labour – work/job people can engage in only with training

• Specialised labour – work/job that only professionals/specialistscan engage



Natural Calamities

Typhoon Sendong

Earthquake in Japan 2011



What will happen to AS?

• Now it’s your turn, what will happen to AS in the aftermathof calamities?

• How will national output be affected?



Stagflation

• An undesirable combination in the health of the economy

• Stagnation – national output is not increasing, productionin the economy is not improving

• Inflation – general price-levels increase

• The combination of both, decreasing output andincreasing price causes economic recessions and laterdepressions



Stagflation

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