Aggregate demand and supply

Aggregate demand and supply

Données clés

Professeur(s)	Sbergami, Federica Nicolas Maystre
Cours	Introduction à la macroéconomie

Lectures

• Aspects introductifs de la macroéconomie
• Le Produit Intérieur Brut (PIB)
• L'indice des prix à la consommation (IPC)
• Production et croissance économique
• Chômage
• Marché financier
• Le système monétaire
• Croissance monétaire et inflation
• La macroéconomie ouverte : concepts de base
• La macroéconomie ouverte: le taux de change
• Equilibre en économie ouverte
• L'approche keynésienne et le modèle IS-LM
• Demande et offre agrégée
• L'impact des politiques monétaires et fiscales
• Trade-off entre inflation et chômage
• La réaction à la crise financière de 2008 et la coopération internationale

Comme nous avons vu dans le chapitre précédent, les économies fluctuent fortement autour de leur niveau de production de plein emploi. Pendant une récession on aura une baisse de l’activité économique et une sous-utilisation des facteurs de production (y compris du chômage). Pendant un boom ou expansion on aura une sur-utilisation des facteurs de production.

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  Taux de chômage en Suisse (1990 - 2008)

Economists use the aggregated demand and supply model (DA-OA) to analyse fluctuations in economic activity around the long-term trend.

The DA-OA and IS-LM models are closely related. In particular, it can easily be shown that the aggregate demand function captures all the pairs (Y, P) that ensure the simultaneous equilibrium of the B&S market (IS curve) and the money market (LM curve). The main difference between these two models is that the IS-LM model considers the general price level as exogenous and is therefore not equipped to analyse the long-term effects of macroeconomic policies. In contrast, the DA-OA model is able to show how the general price level and real GDP are determined simultaneously.

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Aggregate demand

Aggregate demand

Aggregate demand (AD) indicates the quantity of goods and services produced in the domestic economy that is demanded by consumers, investors, government and the rest of the world for each general price level in the economy (NB.: Total expenditure E in the IS-LM model rather highlights the link between demand and income):

$DA=C+I+G+NX$

Aggregate demand, like demand for a good, decreases with the price level => DA(P) , but for reasons that are different from those - specific to the microeconomy.

One of the reasons why demand for a good increases when the price decreases is the substitution effect with other goods. If the price of coffee decreases relative to the price of chocolate (relative price change), more coffee is consumed relative to chocolate (assuming that coffee and chocolate are substitutable goods).

With aggregate demand, there is no substitution effect by definition.

AD and the general price level

1. Wealth effect and consumption: as we saw in chapter 8, when prices fall individuals feel richer, because a 1$ can buy more than before (the value of money ↑) → their consumption increases → AD increases.
2. The effect on interest rate and investment: as we saw in chapter 8, when prices ↓ households need less money for transaction reasons → they offer more loanable funds at r parity → this causes a decrease in the equilibrium interest rate and thus an increase in investment because it becomes cheaper to borrow to invest (more investments become profitable with a lower interest rate) → AD increases.
3. The effect on the trade balance: if the prices of locally produced goods fall, the demand for these goods increases in relation to the demand for goods produced in the WDR → exports increase and imports decrease → AD increases.

The AD is an inverse function of prices.

Travel of the AD

Price is not the only factor influencing aggregate demand → exogenous shocks that can influence the position of the DA :

1. Change in willingness to consume (versus save) = marginal propensity to consume (mpc). This can be caused in turn by an increase in life expectancy, by expectations of a recession or boom, by a property bubble, by an exogenous variation in household wealth, etc.
2. Change in willingness to invest (expectations over the business cycle)
3. Changes in government spending
4. Changes in net demand from the rest of the world: a recession abroad will reduce domestic net exports and thus cause a shift in AD.

Form and position of the AD

Short- and long-term offer

Short- and long-term aggregate offer

In the long run the aggregate offer curve (AO) is totally inelastic, because the quantity produced of goods and services at full employment does not depend on prices, but on the available quantities of the factors of production and technical knowledge → The aggregate supply that corresponds to the level of full employment (or natural, or potential) production is therefore not dependent on prices and shifts when the supply of one of the factors of production changes, or when there is a change in technological knowledge.

In the short run the aggregate offer curve (AO) is elastic, and the quantity of goods and services on offer increases or decreases with the price level in the economy. Because of frictions in the economic system in the short run, which cause the price level expected by individuals to be different from the observed price level (market imperfections), when the observed price level is higher (lower) than the expected price level, one will produce more (less) than at the level of full employment.

AO and the general price level

1. Sticky wages theory: when prices fall, wages take longer to adjust (contracts are fixed for relatively long periods). Producers therefore face lower prices, but with costs as high as they were before the price drop → they will reduce the level of production and employment → AO falls.
2. Sticky prices theory: prices fall, but some companies take a long time to adjust them (menu costs). Demand is falling for those firms that do not adjust prices quickly, so they will have to reduce the quantities produced and employment → AO is falling.
3. Misperception theory: prices are falling, but some firms do not realize that this is a general decline and think that it is only their prices that are falling (relative price decline), and therefore reduce their output and employment → AO is falling.

Whenever there is a gap between the observed price and the expected price, this gap is reflected to a greater or lesser extent (depending on an alpha parameter) in a change in supply relative to the level of full employment output.

Short-term output (Y) = Full employment output ($Y_{P}E$) + α [Observed price (P) - Anticipated price ($P^{e}$)]].

FO is a direct function of prices.

Shifts in the short-term offer curve

Shocks that can influence the AO's position:

In the short term $Y=Y_{P}E+\alpha (P-P^{e})$ => the short term supply function shifts for the same reasons that cause a shift in the long term supply curve: increased productivity or supply of production factors ($L$, $K$, $H$, or $N$) or improved technological knowledge ($A$).

But there is an additional reason that causes the short-term OA curve to shift: changes in price expectations cause shifts in aggregate short-term supply. In particular, a rise in the expected price causes a short-term OA ↓ for any observed price (moving the curve to the left → it is anticipated that production costs will rise and the level of production at observed price parity is lowered).

Shape and movement of the AO

Short-term fluctuations

Equilibrium

Moving the Aggregate Demand AD

A contraction of the AD (generalized pessimism, decrease of $G$, ...) causes :

1. in the short term, a decrease in production, and a drop in prices (recession) ...

A contraction of the AD (generalized pessimism, decrease of $G$, ...) causes :

... 2. in the long term, a decrease in prices but no decrease in output (because expectations adjust, which shifts the aggregate supply to the right: in $B$, $Y<Y_{P}E$ → expectations of a gradual decrease in prices → nominal wages adjust → production costs ↓ → supply ↑ → we come back to $Y_{P}E$)

NB: in the short term, fluctuations! Y</math>Y</math> is temporarily below $Y_{P}E$. In the long term the demand shock is completely absorbed by a price change and $Y$ <revenues to $Y_{P}E$.

Displacement of the AO

A contraction of the AO (natural disaster, wage demands, ...) causes :

1. in the short term "stagflation": P↑ and Y↓ = recession + inflation ...

A contraction of the AO (natural disaster, wage demands, ...) causes :

... 2. in the long term, nothing because the adjustment of expectations will cause a shift in the aggregate supply curve to its initial position (same reasoning as for the long-term effects of a fall in AD: $Y<Y_{P}E$ → expectations of a gradual fall in prices → ...)

Les fluctuations de l'output de court terme sont corrigées automatiquement dans le long terme.

3. In the case of a government intervention aimed at counteracting the initial decline in AO there is a risk of further damage (↑P). This is one of the reasons why, according to the monetarists, the government should not intervene in the economic system (risk of introducing even more serious distortions).

NB.: Une augmentation de la DA (intervention du gouvernement ayant comme but de s’opposer à la contraction initiale de l’OA) provoque encore plus d’inflation.

Which model for the interest rate?

In Chapter 6 we determined the interest rate as the equilibrium rate that equals the amount of loanable funds offered by savers and the amount of loanable funds demanded to finance the investment. In Chapter 11 we determined the interest rate as the equilibrium rate that equals the demand for and supply of money. Now that we have clarified the short- and long-term concepts, it is easy to show that the lendable funds model and the liquidity preference model are compatible and consistent.

In the short run, a fall in the interest rate caused by a ↑ of M increases investment and thus GDP. The ↑ of GDP in turn increases consumption, but also savings (see graphs on the next page). By how much does saving increase? Exactly by the increase in I (at equilibrium: I = S).

In the short term it is the supply and demand for money that determines the interest rate and the market for loanable funds adjusts.

In the long run, we know that the supply of money does not influence the interest rate and that any change in M translates into a proportional change in P. As the general price level ↑ increases, the demand for money increases in the same proportion (shift in the curve). With the price adjustment, Y returns to its full employment level (and thus the supply function of lendable funds to its initial position) and the interest rate to its initial level (see charts on the next page).

In the long term, it is the supply and demand for loanable funds from the product of full employment that determines the interest rate.

Short vs. long term

Reminder of the main differences between long-term and short-term approaches in macroeconomics.

Three central macroeconomic variables to understand this distinction :

• the production of goods and services;
• the real interest rate;
• the general price level.

À long terme

1. La production est déterminée par l'offre de capital et de travail ainsi que par la technologie de production disponible afin de transformer ces facteurs en un certain niveau de production (qui est souvent appelé le taux « naturel » de production).
2. Pour tout niveau de production, le taux d'intérêt réel équilibre l'offre et la demande de fonds prêtables.
3. Le niveau général des prix équilibre alors l'offre et la demande de monnaie. Les modifications de l'offre de monnaie engendrent des modifications proportionnelles du niveau général des prix.

N.B. Les trois propositions ci-dessus représentent l'essentiel de la théorie économique classique. La majorité des économistes pensent que ces propositions sont adéquates pour décrire le fonctionnement de l'économie dans le long terme.

À court terme

Les propositions du point précédent ne sont plus valides. Ainsi, dans le court terme, il est préférable de penser le fonctionnement de l'économie comme suit :

1. Le niveau général des prix est fixé à une certaine valeur (déterminée en fonction des anticipations passées) et dans le court terme il ne réagit que faiblement aux changements des conditions économiques.
2. Pour tout niveau général des prix,le taux d'intérêt s'ajuste afin d'équilibrer l'offre et la demande de monnaie.
3. Le niveau de production répond aux modifications de la demande agrégée de biens et services, qui est en partie déterminée par le taux d'intérêt réalisant l'équilibre du marché de la monnaie.

Résumé

Les fluctuations économiques sont difficiles à prédire et les économistes utilisent le modèle de demande agrégée (DA) et offre agrégée (OA) pour analyser ces fluctuations dans le court terme.

La demande agrégée a une pente négative dans l’espace (quantité, niveau général des prix) due à un effet “fortune”, un effet sur le taux d’intérêt et un effet sur la balance commerciale.

Tout choc qui affecte la consommation, l’investissement, les dépenses publiques et le solde de la balance commerciale va provoquer des mouvements de la fonction de demande.

Dans le long terme l’offre agrégée est verticale, mais dans le court terme elle a une pente positive, dans l’espace (quantité, niveau général des prix)

Il y a 3 explications possibles pour cette pente positive à courte terme: des salaires rigides, des prix rigides, ou des perceptions erronées.

Les déplacements de la courbe d’offre à court terme sont expliqués par les mêmes facteurs que les déplacements de la courbe d’offre à long terme.

Mais il existe une raison supplémentaire: les variations des anticipations sur le niveau de prix vont affecter la position de la courbe d’offre.

Les changements dans la demande et dans l’offre agrégée vont provoquer à court terme des changements dans le niveau d’output et des prix.

Mais à long terme les changements dans la demande agrégée vont provoquer seulement des changements dans le niveau des prix et l’offre agrégée se réajuste et on retourne à l’équilibre initial.

À court terme on peut essayer de corriger l’impact d’une contraction de l’offre agrégée en stimulant la DA (avec une augmentation de la dépense publique par exemple), et ceci va augmenter l’output a court terme, mais va aussi provoquer une augmentation du niveau général de prix plus grande que celle provoquée initialement par la contraction de l’OA.