4.3: A Model of the Macro Economy
Read these lecture notes, which provide details on macroeconomic equilibrium. This resource also provides a foundation for distinguishing time frames, policy impacts, and other important aspects of a key model.
Read this chapter and answer the "Try It" exercises at the end of each section. This reading will provide you with the details and examples needed to master aggregate demand and aggregate supply.
Watch this lecture about aggregate demand and aggregate supply.
4.3.1: Aggregate Demand and Aggregate Supply Curves
The "Aggregate Demand” video lecture assigned below Subunit 4.3 covers this topic. Please pay special attention to the components that constitute aggregate demand and the factors that affect each of these components, resulting in shifts of the AD curve. These lecture notes also explain why the AD curve is negatively-sloped. If you have studied microeconomics, you may remember that the reason for the negative slope of the AD curve is different than what it was for the individual/market demand curve. For Aggregate Supply (AS), please be aware of the distinction between the Short-Run AS curve and the Long-Run AS curve and the factors that lead to shifts or changes in the two curves, respectively. Finally, look at how the AD and the AS interact to reach equilibrium.
The aggregate demand curve slopes downward due to the price level and consumption (i.e., the wealth effect), the price level and investment (i.e., the interest rate effect), and the price level and net exports (i.e., the exchange rate effect).
There are numerous factors that affect the quantity of goods and services demanded at a given price level. When a factor changes, the aggregate demand curve shifts left or right.
Watch this lecture about shifts in aggregate demand.
4.3.2: Macroeconomic Equilibrium
Macroeconomic equilibrium is determined when a country's data indicates that its GDP is equal to its aggregate expenditures and when its savings is equal to its investments. Adjustments toward equilibrium occur when a country's consumption equals its investments and its savings equals its investments. Consequently, the country has zero unplanned changes in inventory and its GDP equals its aggregate expenditure.
Macroeconomic equilibrium may or may not reflect attainment of the three basic macroeconomic goals. A gap is likely to exist between the actual GDP and the full employment or potential GDP, which can mean that employment can be too low or too high. The former refers to unemployment, and the latter refers to inflation; both are undesirable and often lead to instability arising from actions that attempt to address the gap.
Follow the instructions for this simulation to explore how Aggregate Demand (AD) and Aggregate Supply (AS) interact in theory and in reality. The demonstration provides you with three real world economic issues:
- The 1973 Oil Crisis: The price of oil quadrupled after OPEC countries, in a show of strength, drastically reduced production.
- The "New Economy" of the 1990s: A time of optimism and as Alan Greenburg famously said, “irrational exuberance."
- Deflation in Japan: Deflation is just a damaging as inflation, and this case study explores that phenomena.
To complete each case, try to find the "right" answer (appropriate AD and AS policies (expansionary or contractionary) BUT also explore how other options would impact our economy. As you will learn from the various options in the cases, we didn’t always get it right the first time!
During the Great Depression, the government, in good faith, unknowingly applied the very opposite policies of those which were needed and exacerbated the depression, pushing us into the Great Depression. It was only after Keynes wrote his seminal work in 1936 that we started to develop the tools needed to prevent another Great Depression. We are still perfecting those tools. It worth noting that "deflation" is a relatively new phenomena, and Japan’s struggle with it (ongoing since 1997) continues.
- The 1973 Oil Crisis: The price of oil quadrupled after OPEC countries, in a show of strength, drastically reduced production.
After reviewing the material in the previous resource, please post and respond to the following topics on the course discussion board. Feel free to start your own related posts and respond to other students' posts as well.
After working with the three case studies in the previous resource, consider posting some of your findings, your thoughts, and your questions. Perhaps you will find other students with whom you can discuss possible solutions to the deflationary trap in which Japan finds itself. Consider this: the US may soon be in the same kind of deflationary trap as Japan. What do you think can be done?