Building the Model: Aggregate Supply

The aggregate supply is the relationship between the quantity of real GDP supplied and the price level when all other influences on production plans (the money wage rate, the prices of other resources, and potential GDP) remain constant. The AS curve, as shown in Figure 6.1, is upward-sloping. This slope reflects that a higher price level, combined with a fixed money wage rate, lowers the real wage rate, thereby increasing the quantity of labor employed and, hence, increasing real GDP. The potential GDP line is vertical because it is moving along at both the price level rate and money wage rate, and money prices of other resources change by the same percentage. ⁽²⁰⁾

With a velocity of 1.87, for example, people wish to hold a quantity of money equal to 53.4% (1/1.87) of nominal GDP. Other things unchanged, an increase in money demand reduces velocity, and a decrease in money demand increases velocity.
Combined with increased government expenditure, the growing quantity of money limited the fall in aggregate demand, thus resulting in smaller decreases in employment and real GDP. (21) The 2008–2009 Recession. At the peak in 2008, real GDP was $15 trillion and the price level was 99.
The quantity of real GDP demanded equals $16.2 trillion when the price level is 90. If the price level rises to 95, the quantity of real GDP demanded equals askedJul 6, 2016in Economicsby Purplex A) less than $16.2 trillion.

Why does the AS Curve Slope Upward?

The quantity theory of money states that the supply of money times the velocity of money equals nominal GDP. According to the classical dichotomy, real variables, such as real GDP, consumption, investment, the real wage, and the real interest rate, are determined independently of nominal variables, such as the money supply.

When the price level rises and the money wage rate is constant, the real wage rate falls and employment increases. The quantity of real GDP supplied increases. When the price level falls and the money wage rate is constant, the real wage rate rises and employment decreases. The quantity of real GDP supplied decreases. When the price level changes and the money wage rate and other resource prices remain constant, real GDP departs from potential GDP and there is a movement along the AS curve. ⁽²⁰⁾

What Shifts the Aggregate Supply?

Aggregate supply changes when any influence on production plans, other than the price level, changes. In particular, aggregate supply changes when:

Potential GDP changes
The money wage rate changes
The money prices of other resources change

When potential GDP increases, aggregate supply increases and the AS curve shifts rightward. The potential GDP line also shifts rightward. Short-run aggregate supply changes and the AS curve shifts when there is a change in the money wage rate or other resource prices. A rise in the money wage rate or other resource prices decreases short-run aggregate supply and shifts the AS curve leftward. In this case, the potential GDP line does not shift. ⁽²⁰⁾

Building the Model: Aggregate Demand

Aggregate Demand

The quantity of real GDP demanded is the sum of consumption expenditure ( C ), investment ( I ), government expenditures ( G ), and net exports ( X âˆ’ M ), or:

Y = C + I + G + (X — M)

X = Exports and M = Imports

The relationship between the quantity of real GDP demanded and the price level is called aggregate demand . Other things remaining the same, the higher the price level, the smaller is the quantity of real GDP demanded. In Figure 6.2, the AD curve is downward sloping. Moving along the aggregate demand curve, the only thing that changes is the price level. ⁽²⁰⁾

Why does the AD Curve Slope Downward?

There are three reasons for the negative relationship between the price level and the quantity of real GDP demanded:

The buying power of money : When the price level rises, the buying of money decreases and so people decrease consumption expenditure.
The real interest rate : When the price level rises, the demand for money increases, which raises the nominal interest rate. Because the inflation rate does not immediately change, the real interest rate also rises so that people decrease their consumption expenditure and firms decrease their investment.
The real price of exports and imports : When the price level rises, domestic goods become more expensive relative to foreign goods, so people decrease the quantity of domestic goods demanded. ⁽²⁰⁾

What Shifts the Aggregate Demand?

Any factor that influences expenditure plans, other than the price level, changes aggregate demand and shifts the aggregate demand curve. Factors that change aggregate demand are:

Expectations : Expectations of higher future income, expectations of higher future inflation, and expectations of higher future profits increase aggregate demand and shift the AD curve rightward.
Fiscal policy and monetary policy : The government influences the economy by setting and changing taxes, making transfer payments, and purchasing goods and services, which is called fiscal policy. Tax cuts, increased transfer payments, or increased government purchases increase aggregate demand. Monetary policy consists of changes in interest rates and in the quantity of money in the economy. An increase in the quantity of money and lower interest rates increase aggregate demand.
The world economy : Exchange rates and foreign income affect net exports ( X âˆ’ M ) and, therefore, aggregate demand. A decrease in the exchange rate or an increase in foreign income increases aggregate demand. ⁽²⁰⁾

25.2 Demand, Supply, and Equilibrium in the Money Market

Learning Objectives

Explain the motives for holding money and relate them to the interest rate that could be earned from holding alternative assets, such as bonds.
Draw a money demand curve and explain how changes in other variables may lead to shifts in the money demand curve.
Illustrate and explain the notion of equilibrium in the money market.
Use graphs to explain how changes in money demand or money supply are related to changes in the bond market, in interest rates, in aggregate demand, and in real GDP and the price level.

In this section we will explore the link between money markets, bond markets, and interest rates. We first look at the demand for money. The demand curve for money is derived like any other demand curve, by examining the relationship between the “price” of money (which, we will see, is the interest rate) and the quantity demanded, holding all other determinants unchanged. We then link the demand for money to the concept of money supply developed in the last chapter, to determine the equilibrium rate of interest. In turn, we show how changes in interest rates affect the macroeconomy.

The Demand for Money

In deciding how much money to hold, people make a choice about how to hold their wealth. How much wealth shall be held as money and how much as other assets? For a given amount of wealth, the answer to this question will depend on the relative costs and benefits of holding money versus other assets. The demand for moneyThe relationship between the quantity of money people want to hold and the factors that determine that quantity. is the relationship between the quantity of money people want to hold and the factors that determine that quantity.

To simplify our analysis, we will assume there are only two ways to hold wealth: as money in a checking account, or as funds in a bond market mutual fund that purchases long-term bonds on behalf of its subscribers. A bond fund is not money. Some money deposits earn interest, but the return on these accounts is generally lower than what could be obtained in a bond fund. The advantage of checking accounts is that they are highly liquid and can thus be spent easily. We will think of the demand for money as a curve that represents the outcomes of choices between the greater liquidity of money deposits and the higher interest rates that can be earned by holding a bond fund. The difference between the interest rates paid on money deposits and the interest return available from bonds is the cost of holding money.

Motives for Holding Money

One reason people hold their assets as money is so that they can purchase goods and services. The money held for the purchase of goods and services may be for everyday transactio

The Quantity Of Money Demanded Is Equal To Real Gdp