Limitations of the Aggregate Expenditure Model §

• AE Model focuses on the impact of a change in spending on output. (says nothing about impact of changing expenditure on ge neral prices, therefore does not say anything about inflation)
• Therefore ignores supply side of the economy
• AE Model only focuses on demand side of economy.
  • Changes in labour force, Capital Stock, Level of Technology, Rising productivity not considered in AE Model

The Aggregate Demand / Supply model is a more “complete model”

Aggregate Demand §

AD is the total amount of demand for final goods & services (GDP) at any point in time.

• AD is similar in definition to AE
• AD different when presented as a model

Aggregate Demand shows a negative relationship between demand and the price level.

• X Axis shows level of output. Labelled Real GDP.
• Y-Axis shows Price Level.

Excali-Aggregate-Demand-Diagram.excalidraw

Why is there a negative relationship between AD & Price Level §

• The Wealth Effect As ⬆ Price Level / Inflation leads to > ⬇Household “Wealth” (purchasing power) leads to > ⬇Houeshold Consumption (⬇)
• The Interest Rate Effect As ⬆ Price Level / Inflation leads to > ⬆ Interest Rates leads to > ⬇ Investment & ⬇ Consumption (⬇ AND ⬇)
• The Open Economy Effect As ⬆ Price Level / Inflation leads to > ⬆ Relative Inflation Rates leads to > ⬇International Competitiveness & ⬆ Imports causes ⬇Net Exports

Simply; if⬆Price Levels (which is ⬆Inflation) expect total spending in the economy to fall.

Which would cause a movement up & left along the AD curve as shown below. ⬇ Price Levels likely cause a movement to the right

Shifts of the entire AD curve §

If any factor other than price levels change demand, the whole curve will shift. This could be anything that influences any of the components of Aggregate Expenditure.

#econs-example

If the government reduced income tax, ⬆ Disposible income > ⬆ Household spending. This non price level factor would shift the aggregate demand curve right. (an increase in AD) Other non-price factor examples that would shift it to the right include;

• ⬆Consumer Confidence
• ⬇ Interest Rates
• ⬆ Household wealth from ⬆ Property Values
• ⬆ Government Spending
• High Economic Growth in China > ⬆ Aus. Exports Increases in AD represent ⬆ Real GDP, ⬆Income, and ⬆Employment

It might shift to the left for;

• ⬇Business Confidence > ⬇Investment Spending
• ⬆ Interest Rates > Investment Spending
• ⬇Government Spending

Aggregate Supply §

The aggregate supply curve is actually 2 curves.

Long-run Aggregate Supply Curve (LRAS) §

The LRAS curve is vertical, because;

it represents the maximum potential level of output at a particular point in time. (not influenced by price level, therefore it is vertical, since x-axis is price level)

Shifts in the Vertical Position of the LRAS Curve §

LRAS Curve vertical position is determined by;

• Population size
• Labour Influence from Capital
• Work Force Participation

Labour Influence is how much the productivity of labour can be enhanced / ”influenced” by the stock of capital equipment and the current state of technology.

Short-run Aggregate Supply Curve (SRAS) §

• The SRAS curve describes the relationship between total production and the price level. They are positively related. meaning they are “positively sloped”.

This means As economic activity increases, price level rises. This occurs due to the following factors; Firms Increasing production require: Labour resources & Capital resources This demand puts upwards pressure on ⬆resource prices, (wages mainly) This effect is exastrabated as the economy approaches it’s “potential capacity” aka Full Employment. SRAS-Agg.Supply-diagram.excalidraw Wages increases as a result of increased output is especially evident nearing Full Employment as labour becomes more scarce. and therefore costs more.

Shifts in the SRAS Supply Curve §

The SRAS curve is shifted by events that affect the availability of resources or short-term costs of production, e.g; Shift leftwards - Total Production decreased independant of price levels

• Early Stage COVID Supply Shock. Due to Strict lockdowns in China causing disruption to world supply chains
• Increase in Minimimum wage recently Will cause an increase in the costs of production. (#ask_davis will this cause shift or movement???)

Shifts rightwards - Total Production increased independant of price levels

• Technological Improvement
• Fall in price of important input e.g. Oil is an important input in production, a ⬇in oil prices would mean ⬆ GDP & Employment