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CHAPTER 9 -- Part 2: AGGREGATE DEMAND
Investment spending's apparent volatility heightens anxiety rather than calming it.
The investment component of aggregate demand can be unstable.
The consumption component of aggregate demand may change abruptly.
The seeds of failure can be sown by shifts.
Most of the spending occurs at the state and local levels.
State and local governments can't balance their budgets because of tax receipts.
State and local spending is procyclical, with expenditure rising as the economy expands and falling when the economy slumps.
If consumption and investment spending decline, the decline in state-local government spending will be more than offset by the leftward shift of the AD curve.
Federal spending on goods and services is not limited by tax receipts.
The federal government is usually in the red with large budget deficits.
The 3-4 percent forecast was made in November.
The Bank of Canada lowered its estimate of the Canadian economy's growth last year.
The bank said it expects consumer price inflation to be between 3 and 4 percent.
The monetary-policy report was revised last November due to the decline in oil prices.
Canada's central bank said that the U.S. economy has been more abrupt than anticipated.
WALL STREET dian exports go to the U.S.
The Reproduced with permission of DOW JONES & COMPANY, Inc. is likely to grow at the low end of the bank's format Textbook via Copyright Clearance Center.
The majority of Canadian exports go to the US.
A leftward shift in that country's aggregate demand occurs when the U.S. economy slows.
By changing its own spending, Uncle Sam can help reverse AD shifts.
Keynes advocated this kind of government action.
Chapter 11 looks at its potential more closely.
Net exports are the fourth and final source of aggregate demand.
The spending behavior of foreign consumers and businesses affects our gross exports.
In the Asian currency crisis of 1997-99, U.S. exports to Asia of rice, corn, lumber, computers, and other goods and services fell sharply.
The number of Asian students applying to U.S. colleges increased.
The leftward shift of U.S. aggregate demand was represented by the decline in export spending.
There was a shift in Canada's aggregate demand when the U.S. economy slowed.
For the same reasons, imports can be unstable.
Consumer goods and services are the majority of U.S. imports.
The ebb and flow of consumer spending is what causes imports to get caught up.
The four components of spending come together to determine aggregate demand.
Net exports complete the computation.
The rest of the AD curve shows how the quantity of output demanded will change if the price level goes up or down.
The construction of the AD curve is easy.
It requires a lot of information about the intentions of market participants.
We can accurately depict the AD curve if we have all that information.
When we know the shape and position of the AD curve, we can put it together with the AS curve.
Our macro problems may emerge here.
The market might not give us full employment or price stability.
Keynes didn't think a perfect outcome was likely.
Consumers, investors, government, and foreigners make their own spending decisions based on many influences.
Keynes did not think they would.
There is no reason to think that the sum of expenditures will generate the right amount of demand.
There's a high chance that we'll confront an imbalance between desired spending and full-employment output.
Market participants would be willing to buy more output at full employment.
Production would be cut back, workers would be laid off, and prices would decline as unsold inventories rose.
2 isn't a happy equilibrium.
The gap shows unused productive capacity, such as lost GDP and unemployed workers.
Figure 9.11 shows the dilemma with more details.
Fullemployment GDP is more than the table GDP.
The full-employment GDP is $10 trillion and the price is 100.
GDP is $9 trillion and has a price level of 90.
The GDP gap is insufficient.
Demand won't always fall short.
Keynes thought it was a distinct possibility.
Producers will use overtime shifts and strain capacity to meet the excessive demand.
This will cause prices to go up.
Short-run output exceeds sustainable levels when the price level is higher.
equilibrium GDP exceeds full-employment GDP.
Full-employment GDP may be greater than equilibrium GDP.
Things can work out well.
Market participants may change their spending behavior abruptly.
I L I T Y demand.
Investment plans may be altered by changed sales forecasts.
Export sales may be disrupted by foreign economies.
Everybody's boat may be affected by a terrorist attack.
The aggregate demand curve will shift due to any of these events.
The AD curve will be knocked out of its "Perfect" position in Figure riods of economic growth and contraction when this happens.
The supply side of the market place can cause economies to get into trouble.
Keynes's emphasis on demand-side inadequacies serves as an early warning of potential macro failure.
The economy will not reach and maintain the goals of full employment and price stability if aggregate demand is too little, too great, or too unstable.
Keynes was pessimistic about the prospects for macro bliss.
Classical economists said that macro failures would be temporary if markets self-adjust.
The components of aggregate demand need to shift in the right direction at the right time.
Self-adjustment requires that any shortfalls in one component of aggregate demand be offset by spending in another component.
Keynes didn't think that was likely for a number of reasons.
The index is about leading indicators.
Keynes's theory of failure gave policymakers a lot to worry about.
Keynes believed that abrupt changes in aggregate demand could ruin the best of economic times.
If he was wrong about the ability of the economy to self-adjust, there could be a lot of temporary pain.
Policymakers need to look into the future to anticipate shifts of demand.
They might be able to take defensive actions with a crystal ball.
Market participants have developed a variety of crystal balls.
4,000 different crystal balls have been identified by the Foundation for the Study of Cycles.
They include the ratio of used-car to new-car sales, the number of divorce petitions, and the optimism/ pessimism content of popular music.
The Index of Leading Indicators is one of the most widely used crystal balls.
The connection between its components and future spending is appealing.
One of the leading indicators is equipment orders.
Businesses don't order equipment unless they plan to buy it later.
People only get building permits if they plan to build something.
Both indicators seem to be reliable signs of future investment.
The Leading Indicators aren't perfect.
Equipment orders can be canceled.
Building plans are abandoned or delayed.
Everyone wants a crystal ball and sales are expected.
Initial claims for unemployment benefits reflect changes in industry.
The longer it takes to deliver goods, the higher the ratio of demand to supply.
Potential purchasing power is indicated by 11 indicators.
3 to 6 months in advance is when producers buy more activity.
Predicting changes in production capacity and higher anticipated sales can be done with increased orders for new equipment.
Sales and profits are not the leading indicators.
A pickup in the money supply is implied by the faster growth of the money supply.
The first step is a permit.
Companies build up inventory when sales go up.
The timing and magnitude of a natural disaster could not be predicted with a crystal ball.
Compared to other crystal balls, the Index of Leading Indicators has a good track record.
It helps investors and policymakers see what the economy will look like in the future.
There is a difference between disposable full employment and price stability.
When auton demand causes unemployment, the consumption function shifts up or down.
Consumer spending affects future sales and innovation.
Current shifts may work.
LO2 9.10a will be affected by a stock market crash.
There are numerical and graphing problems in the Student Problem Set at the back of the book.
The Keynesian view of the macro economy emphasizes the potential instability of the private sector and the undependability of a market-driven self-adjustment.
The theory was illustrated with shifts of the AD curve.
The AS/AD model shows how the price level and real output are affected by AD shifts.
Keynes' theory of instability was not a threat at the time.
With unemployment rates reaching as high as 25 percent, no one worried that increased aggregate demand would push price levels up.
Getting back to full employment was the only concern.
Early depictions of Keynesian theory didn't use the AS/AD model because inflation wasn't seen as an immediate threat.
The Keynesian cross focuses on the relationship of total spending to the value of total output, without an explicit distinction between price levels and real output.
The Keynesian cross doesn't change the conclusions we've come to about macro instability.
It is an important framework for explaining macro outcomes.
Keynes showed that the level of income affects consumer spending.
The consumption function is put into the larger context of the economy.
The line shows the points where total spending and total income are equal.
Continue until you reach the consumption function.
$3 trillion of income is generated at full employment.
$2,350 billion and save the rest.
The economy would be in trouble if product-market sales were totally dependent on consumers.
The shortfall in consumer spending does not doom the economy.
Aggregate expenditure will be increased by the spending of other market participants.
Keynes said that the spending decisions of investors, governments, and net export buyers are made on their own.
We would have to look at their behavior to figure out how much other market participants might spend.
We could end up with the information in Figure 9A.2 if we did that.
The data shows how much money will be spent at different income levels.
The aggregate expenditure curve was used by Keynes to assess the potential for failure.
He wanted to know how much market participants would spend if the economy were full-employment.
The information in Figure 9A.2 makes it easy to answer that question.
We end up with less aggregate expenditure in product markets than full-employment output.
The economy is in trouble.
Full employment wouldn't last.
3,000 billion of output would be produced at full employment.
Only $2,750 of the output would be sold.
There isn't enough aggregate expenditure to sustain full employment.
That pileup is a sign of trouble.
Aggregate spending at full employment falls short of full employment output because not enough output is willingly purchased at full employment.
The total desired spending is shown by the aggregate expenditure curve.
The economy needs 50 3,125 jobs.
The producers may cut back on production and lay off workers.
You might wonder if the planned spending of market participants would be equal to the output.
It won't be at the rate of output we seek.
The desired rate of output should be remembered.
There would be no difference in output at any point on this line.
Aggregate expenditure is $2,750 billion.
The Keynesian cross is the juxtaposition of the aggregate expenditure function with the 45 degree line.
The Keynesian cross relates aggregate expenditure to the total income.
The equilibrium occurs at an output rate of $2,000 billion.
The accompanying table shows how much market participants want to spend.
No goods remain unsold at this rate of output.
An expenditure equilibrium exists when the spending and the value of output are exactly the same.
Producers can't change the rate of output because they're selling everything they produce.
The equilibrium depicted in Figure 9A.3 isn't what we hoped for.
The economy's productive capacity won't always be met by the expenditure equilibrium.
If aggregate spending at full employment exceeds to buy more output or if the consumption function shifted upward, this might happen.
The bidding war may push the price even higher.
This would be a symptom of failure.
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