9-2: Aggregate Demand ●( goods market S YECCY-T)+lr,)+G (Financial market) LM M/P= YLO e We represent the aggregate demand relation by YEY(M/P, G, D) (92) 十 e Output is an increasing function of the real money stock, an increasing function of government spending and a decreasing function of taxes. Given M, G, t, an increase in price level P leads to a decrease in real money stock, M/P, which leads to a decrease in output This is the relation capture by the Ad curve in Figure 2003-7-20 6
2003-7-20 6 9-2: Aggregate Demand (goods market) IS: Y = C(Y-T) + I(Y,i) + G (Financial market) LM: M/P = YL(i) We represent the aggregate demand relation by Y=Y(M/P, G, T) (9.2) ( + , + , - ) Output is an increasing function of the real money stock, an increasing function of government spending, and a decreasing function of taxes. Given M, G, T, an increase in price level P leads to a decrease in real money stock, M/P, which leads to a decrease in output. This is the relation capture by the AD curve in Figure
Interest rate i LMI (for PI>P LM (for P Price level p AD tput Y
Interest rate i LM¹ (for P¹> P) i¹ LM (for P) i IS Y¹ Y O u t p u t Y Price level p P¹ A ¹ P A AD Y¹ Y Output Y
9-3: Equilibrium Output in the Short and the Medium Run AS relation P=Pe(1+pF(1-Y),2] AD relation YEY(M/P, G,T) The equilibrium is given by the intersection of the two curves at point A By construction, at point A, the goods, financial, and the labor market are all in equilibrium. The fact that the labor market is in equilibrium comes from the fact that point a is on the aggregate supply curve. The fact that goods and financial markets are in equilibrium comes from the fact that point a is also on the aggregate demand curve. The equilibrium level of output and price level are given by Y and P 2003-7-20 8
2003-7-20 8 9-3: Equilibrium Output in the Short and the Medium Run AS relation P= Pe (1+ μ) F[(1-Y/L) , z] AD relation Y= Y ( M/P, G, T ) The equilibrium is given by the intersection of the two curves at point A. By construction, at point A, the goods, financial, and the labor market are all in equilibrium. The fact that the labor market is in equilibrium comes from the fact that point A is on the aggregate supply curve. The fact that goods and financial markets are in equilibrium comes from the fact that point A is also on the aggregate demand curve. The equilibrium level of output and price level are given by Y and P
Figure 9-3: Equilibrium output and price level Price level p AS T AD Output Y
Figure 9-3: Equilibrium output and price level Price level P AS P A Pe B AD Yn Y Output Y
The Dynamics of output and the price level e As we look at the evolution of output and other variable over time, the other thing we need to do is to introduce time indices So, Pt will refer to the price level in year t, Pt-1 to the price level in year t-1, Pt+ 1 to the price level in year t+1, and so on e Using the notation, the assumption that the expected price level equals the price level last year is written as P = P e And the aggregate supply and demand relation must now be AS relation Pt=P1(1+p)F[(1Y+/L),2](93) ● AD relation YI (M/P1, G,TI (94) Note that the parameters (u, z) and the exogenous variables L, M, G, T do not have a time subscript. This is because we shall assume they remain constant, so there is no need for a time 2003-7-20 10
2003-7-20 10 The Dynamics of output and the price level As we look at the evolution of output and other variable over time, the other thing we need to do is to introduce time indices. So, Pt will refer to the price level in year t,Pt-1 to the price level in year t-1,Pt+1 to the price level in year t+1, and so on. Using the notation, the assumption that the expected price level equals the price level last year is written as Pt e = Pt-1 And the aggregate supply and demand relation must now be: AS relation Pt = Pt-1 (1+μ) F [(1-Yt / L), z] (9.3) AD relation Yt = Y[ (M/ Pt ), G, T ] (9.4) Note that the parameters (µ, z) and the exogenous variables L, M, G, T do not have a time subscript. This is because we shall assume they remain constant, so there is no need for a time