Current Events:
Sri-Kumar Sees U.S. Economy Sliding Back Into Recession
Feb. 25 (Bloomberg) -- Komal Sri-Kumar, chief global strategist at TCW Group Inc., talks with Bloomberg's Carol Massar and Matt Miller about the outlook for the U.S. economy. Sri-Kumar also discusses U.S. stocks, the Obama administration's policies and Greece's debt crisis. (Source: Bloomberg)
Aggregate Demand and Supply Ch. 19
Chapter Overview
If you chose not to cover the Keynesian model you can still move seamlessly into this chapter; it even presents the spending multiplier in the context of the AS/AD model. The Great Depression is covered (as also in the previous chapter on the Keynesian model) and the chapter also discusses cost-push and demand-pull inflation. Of particular note is the extensive coverage given for the aggregate supply curve; the slope of the curve is explicitly related to the time period under consideration (this is an excellent treatment of why the aggregate supply curve can have different slopes). If you have covered the Keynesian model and wish to relate it to the AS/AD model, an Appendix to the chapter illustrates how the AD curve is derived from AE.
Investment, p. 503 (Marginal Efficiency of Capital--Classical, or, Accelerator Theory--Keynes), 5:37
Determinants of Aggregate Supply, p. 507
Input Prices, p. 507
Productivity, p. 507
Taxes, p. 508
Market Power of Firms, p. 508
Expectations, p. 508
Checkpoint: Aggregate Supply, p. 509
Macroeconomic Equilibrium, p. 509
The Spending Multiplier, p. 510
Using AS/AD: The Great Depression, p. 511
Using AS/AD: Demand-Pull Inflation, p. 512
Using AS/AD: Cost-Push Inflation, p. 514
Cost-push inflation, 1:16
Deflation and cost push inflation explained by Ellen Hodgson Brown, 3:05
Checkpoint: Macroeconomic Equilibrium, p. 515
Ideas for Capturing Your Classroom Audience
■ (If you did not cover Chapter 18 and therefore the Great Depression, use this
idea.) Make it visual! While students have likely heard about the Great
Depression, most will probably not know how bad things were. Numerous sites
exist on the Web with photos of bread lines and other scenes typical of the time.
This will help make the economic devastation more vivid for students.
■ Illustrate changes in the macroeconomy over time, particularly after the oil price shock of the mid-1970s. Visit the Flashback Economy Web site at
http://www.1970sflashback.com/1970/Economy.asp to illustrate changes in the
price of a gallon of regular gasoline as well as the inflation and unemployment
rates through the 1970s and 1980s.
Contrast between today and 1970 with the following items:
Dow-Jones
High:
Low:
Federal spending:
Federal debt:
Inflation:
Consumer Price Index:
Unemployment:
Prices
Cost of a new home:
Cost of a new car:
Median Household Income:
Cost of a first-class stamp:
Cost of a gallon of regular gas:
Cost of a dozen eggs:
Cost of a gallon of Milk:
■ Look at real and nominal gasoline prices over time using the graph on this page
from the Web site of the Energy Information Administration of the U.S.
Department of Energy. The graph is found at: http://www.fueleconomy.gov/feg
/gasprices/FAQ.shtml.
Aggregate Demand, p. 505
Question: Consumer spending is related to disposable personal income (personal
income minus taxes). Describe how changing tax rates would affect consumption
and aggregate demand.
The point is to check that students can: apply their knowledge of the determinants
of aggregate demand to help evaluate the effect of changing taxes (the key link is
taxes to income to spending).
Aggregate Supply, p. 509
Question: In Europe nearly two-thirds of wages are covered by union collective bargaining agreements; wage rates are determined (or fixed) for a given time period, typically 2 to 4 years. In the United States only about one-sixth of wages are covered. Unemployment rates in Germany, France, and Italy are typically double that (8–12%) of those in the United States (4–6%). Do higher unemployment rates in Germany, France, and Italy mean that their aggregate supply curves are flatter than ours in the United States?
The point is to check that students can: synthesize their knowledge of the effect of collective bargaining on wages (making them, in Keynesian terms, “stickier”) and how this affects the slope of aggregate supply.
Macroeconomic Equilibrium, p. 515
Question: Between 2004 and 2006, the price of petroleum products in the United
States more than doubled and gasoline and diesel fuel peaked at roughly $3.00 a gallon.
Describe the impact of this price increase on aggregate supply. How might it
affect employment, unemployment, and the price level? Would the impact depend
on whether consumers and business thought the price increase was permanent?
The point is to check that students can: understand how changes in the price of oil affect the economy. It might be useful to point out that the initial effect is a decrease in aggregate supply against an unchanging aggregate demand.
Deriving the Aggregate Demand Curve
The Appendix illustrates how the aggregate demand curve can be derived from the
aggregate expenditures model by changing the price level (thus changing the position of the AE line) and finding the new equilibrium level of Y. These points are then translated onto a second set of axes to show the aggregate demand curve.
Examples Used in the End-of-Chapter Questions
Question 13 refers to consumer confidence. Chapter 18 introduced students to the
Conference Board’s monthly survey of 5,000 households called the Consumer
Confidence Index. To learn more about the Index visit the Conference Board’s Web
site at: http://www.conference-board.org/economics/consumerConfidence.cfm.
Many analysts and policymakers also track the index published by Reuters in conjunction with the University of Michigan. See sites like Bloomberg.com for recent releases, or view previous press releases at: https://customers.reuters.com/community/university/default.aspx.
For Further Analysis
The Best of Times and the Worst of Times? Using the AS/AD Model to Explain
the 1970s and the 1990s
This example can be used as an in-class small group exercise or as an individual inclass exercise. It is designed to complement the text’s material by employing the graphical analysis of the AS/AD model to illustrate stagflation and the low inflation–low unemployment that characterized the 1990s. For simplicity the handout uses only short-run analysis, but it is not difficult to incorporate a discussion of whether or not the long-run aggregate supply curve shifts.
Web-Based Exercise
The Effect of Oil in the 1990s; Not Like the 1970s
This example can be used as a small group exercise or as an individual exercise.
The exercise provides an opportunity for students to read research from a Federal
Reserve Bank’s research department and apply it to what they have learned in the
chapter. This serves a subtle purpose of introducing the Federal Reserve System in
advance of its coverage in later chapters. You may also decide to have students read recent articles about oil prices and about whether or not there is still concern about stagflation in order to make this a more extensive assignment.
The Effect of Oil in the 1990s; Not Like the 1970s
Visit the Web site of the Federal Reserve Bank of San Francisco (http://www.
frbsf.org/) to read an article from its Economic Letter (2005-31; November 18, 2005) titled “Why Hasn’t the Jump in Oil Prices Led to a Recession?” The authors (John Fernald and Bharat Trehan) compare the effect of oil prices in the 1970s and in the 1990s. Summarize the main points of the article. This is still a topic very much in the news. (The article reinforces the text material
about the importance of disposable income and about whether price increases are
seen as permanent or temporary. It also makes mention of monetary policy,
which might be a good “promo” for material to come.)
Tips from a Colleague
Perhaps the hardest part of this chapter is the explanation why the aggregate
demand curve has a downward slope, as students are quick to relate it to demand
curves for individual goods. You may want to recall the material about biases in the CPI due to consumers switching among goods when prices change to reinforce the
substitutions that occur when we look at aggregate demand.
Web of Debt, The Shocking Truth About Our Money System
Author Ellen Hodgson Brown talks about her book, how money is created by the banks using an illusion and how we can fix the coming economic meltdown.
1. Be sure to study for a subsequent Ch. 16 Test, TBA.
2. Be sure to review Ch. 17 (we will have Quizzes and a Test on Ch. 17, TBA).
3. Ch. 19, this material, in contrast to the older material, is new and you should answer in writing as part of your HW:
■ Illustrate changes in the macroeconomy over time, particularly after the oil price shock of the mid-1970s. Visit the Flashback Economy Web site at
http://www.1970sflashback.com/1970/Economy.asp to illustrate changes in the
price of a gallon of regular gasoline as well as the inflation and unemployment
rates through the 1970s and 1980s.
Contrast between numbers and costs between today and 1970 by researching the data in regards to the following items:
Dow-Jones
High:
Low:
Federal spending:
Federal debt:
Inflation:
Consumer Price Index:
Unemployment:
Prices
Cost of a new home:
Cost of a new car:
Median Household Income:
Cost of a first-class stamp:
Cost of a gallon of regular gas:
Cost of a dozen eggs:
Cost of a gallon of Milk:
