Economic aggregate and relationship

Aggregate behavior - Wikipedia

economic aggregate and relationship

Aggregate supply and demand is the total supply and total demand in an These curves illustrate the relationships among price points, time. E. Forests and Trees: The Relationship between Macroeconomic and . Macroeconomics is the study of the relationships among aggregate economic var -. In macroeconomics, aggregate demand (AD) or domestic final demand (DFD) is the total The aggregate demand curve illustrates the relationship between two factors: the quantity of output that is demanded and the aggregate price level.

A more realistic model would assess a tax rate as some proportion of Y. Now we come to a textbook chestnut: Or we lower taxes and lower government purchases by the same amount. What is the net effect on the economy?

You already have a sense of the answer, from our comparison of the effects of similar changes in G and T above. Because a change in G affects AD fully, while a change in T affects AD only in slightly diminished form by changing C first through the MPCchanging spending is just a little more powerful than changing taxes.

And in fact, you already know enough to tell exactly how much change in Y will be provoked by a matched change in G and T. And by doing that: And in fact, in this simple model the balanced budget multiplier is always exactly 1.

economic aggregate and relationship

If algebra makes you happy, you can get this result by adding up the two abstract formulas: When the economy is booming and inflationary pressures start to grow in the economy, the Government can decrease G and increase T. If the budget is normally more or less in balance, then this means that the government runs deficits in recessions, and surpluses in booms.

Aggregate demand and aggregate supply curves

This should stabilize the level of aggregate expenditure and income in an economy. When the government does this, it is called counter-cyclical policy.

Essentially the government is trying to damp down swings in Y. If these swings in Y are part of a normal "business cycle" in which periods of intense capital investment alternate with periods in which firms buy relatively few new capital goods, then it's especially easy to see the rationale for counter-cyclical G: If firms' intended investment Ip falls, that's a component of AD and Y will tend to fall.

In that case, in theory, G can be increased to make up for the fall in Ip. In real life, this is hard because it may take a while to actually figure out that Ip is dropping, and the political process of approving changes in G or T may drag on for long enough that by the time fiscal policy is actually changed, Ip has risen again. In this case your intended counter-cyclical policy might actually end up being a pro-cyclical policy, amplifying rather than damping the changes in Ip.

Counter-cyclical policy would also lower G when Ip rises, to reduce booms. You might wonder why anyone would want to do this - aren't booms good? The most often-heard arguments are a that a boom sets up conditions for a painful crash by encouraging over-investment too much Ip, so that it collapses once firms realize they have bought too many machines and b that overly-rapid growth provokes rapid inflation.

But in a more sophisticated model, transfer payments and taxes in particular will change as Y changes. If tax revenues are a percentage of income, then as Y rises taxes will rise by themselves. If transfers like unemployment compensation rise when people lose their jobs and fall when employment rises, then when Y rises transfers fall, and when Y falls transfers rise.

So since net taxes T represent total taxes minus transfer payments, it follows that T will rise when Y rises and fall when Y falls. Note that this amounts to a counter-cyclical policy as described in the previous section, but that it's automatic - it requires no extra decision by government to do this.

This kind of countercyclical policy is also pretty rapid. Another way of saying the same thing is that it sells securities IOUs.

economic aggregate and relationship

But suppose the government already owes money from previous deficits. Then this year's deficit adds to the total debt of the government.

Aggregate demand - Wikipedia

So the federal debt is the total amount owed by the federal government, while the deficit os the amount this debt rises in a single year. In other words the debt is the cumulative total of all past deficits. Some of this debate has been interesting, and reasonable people can take very different positions on taxing, spending, and deficits.

But unfortunately a lot of the discussion has been based on the fallacy that national debt is just like personal debt.

Personal debt has to be paid off by a certain point: I might take out loans to go to college, but I won't be able to continue borrowing forever lenders know I have a finite earning lifeand at some point I have to pay it all back. Additionally, because it has the power to tax nobody will worry about its ability to pay back in the future. So government can keep "rolling over" its borrowing: Of course it still has to pay interest, but the "principal" - the amount of the original borrowing - never has to be repaid.

This does not mean that we have discovered some kind of magic beans. Government borrowing does have consequences and they can be, arguably, bad.

But to think about those consequences you have to think in real terms: Let's tick off some not all of the reasons that deficits might harm or help.

Macro Notes 1: Aggregate Demand

The AS curve describes how suppliers will react to a higher price level for final outputs of goods and services while the prices of inputs like labor and energy remain constant. If firms across the economy face a situation where the price level of what they produce and sell is rising but their costs of production are not rising, then the lure of higher profits will induce them to expand production.

Potential GDP If you look at our example graph above, you'll see that the slope of the AS curve changes from nearly flat at its far left to nearly vertical at its far right. At the far left of the aggregate supply curve, the level of output in the economy is far below potential GDP—the quantity that an economy can produce by fully employing its existing levels of labor, physical capital, and technology, in the context of its existing market and legal institutions.

At these relatively low levels of output, levels of unemployment are high, and many factories are running only part-time or have closed their doors.

Aggregate behavior

In this situation, a relatively small increase in the prices of the outputs that businesses sell—with no rise in input prices—can encourage a considerable surge in the quantity of aggregate supply—real GDP—because so many workers and factories are ready to swing into production. As the quantity produced increases, however, certain firms and industries will start running into limits—for example, nearly all of the expert workers in a certain industry could have jobs or factories in certain geographic areas or industries might be running at full speed.

In the intermediate area of the AS curve, a higher price level for outputs continues to encourage a greater quantity of output, but as the increasingly steep upward slope of the aggregate supply curve shows, the increase in quantity in response to a given rise in the price level will not be quite as large. At the far right, the aggregate supply curve becomes nearly vertical. At this quantity, higher prices for outputs cannot encourage additional output because even if firms want to expand output, the inputs of labor and machinery in the economy are fully employed.

In our example AS curve, the vertical line in the exhibit shows that potential GDP occurs at a total output of 9, When an economy is operating at its potential GDP, machines and factories are running at capacity, and the unemployment rate is relatively low at the natural rate of unemployment. The aggregate supply curve is typically drawn to cross the potential GDP line. This shape may seem puzzling—How can an economy produce at an output level which is higher than its potential or full-employment GDP?

The economic intuition here is that if prices for outputs were high enough, producers would make fanatical efforts to produce: Such hyper-intense production would go beyond using potential labor and physical capital resources fully to using them in a way that is not sustainable in the long term.

economic aggregate and relationship

Thus, it is indeed possible for production to sprint above potential GDP, but only in the short run. So, in the short run, it is possible for producers to supply less or more GDP than potential if demand is too low or too high. In the long run, however, producers are limited to producing at potential GDP.

The Aggregate Demand Curve Aggregate demand, or AD, refers to the amount of total spending on domestic goods and services in an economy. Strictly speaking, AD is what economists call total planned expenditure. We'll talk about that more in other articles, but for now, just think of aggregate demand as total spending.

Aggregate demand includes all four components of demand: Consumption Government spending Net exports—exports minus imports This demand is determined by a number of factors; one of them is the price level. An aggregate demand curve shows the total spending on domestic goods and services at each price level. You can see an example aggregate demand curve below. Just like in an aggregate supply curve, the horizontal axis shows real GDP and the vertical axis shows price level. But there's a big difference in the shape of the AD curve—it slopes down.