{"id":7657,"date":"2017-12-31T15:10:58","date_gmt":"2017-12-31T15:10:58","guid":{"rendered":"https:\/\/courses.lumenlearning.com\/wm-macroeconomics\/?post_type=chapter&#038;p=7657"},"modified":"2018-06-05T20:41:43","modified_gmt":"2018-06-05T20:41:43","slug":"real-aggregate-supply-in-the-income-expenditure-model","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/oldwestbury-wm-macroeconomics\/chapter\/real-aggregate-supply-in-the-income-expenditure-model\/","title":{"raw":"Real Aggregate Supply in the Income-Expenditure Model","rendered":"Real Aggregate Supply in the Income-Expenditure Model"},"content":{"raw":"<div class=\"textbox learning-objectives\">\r\n<h3>Learning Objectives<\/h3>\r\n<ul>\r\n \t<li>Explain aggregate supply in the income-expenditure model and how the income-expenditure model correlates to the AD-AS model<\/li>\r\n<\/ul>\r\n<\/div>\r\nWe observed earlier the income-expenditure model doesn't explicitly discuss aggregate supply, but it's straightforward to add that, if we think of the aggregate supply curve as answering the question: how do producers respond to a change in aggregate demand?\u00a0Recall Figure 1 below from our earlier discussion of aggregate demand in the Keynesian model. Figure 1 shows the pure Keynesian AD-AS model. Let's think about how this corresponds to the income-expenditure model.\r\n<div id=\"post-633\" class=\"post-633 chapter type-chapter status-publish hentry type-1\">\r\n<div class=\"entry-content\">\r\n<div id=\"m48750-CNX_Econ_C25_031\" class=\"figure\" title=\"Figure\u00a011.3.\u00a0The Keynesian AS\u2013AD Model\">\r\n<div class=\"body\">\r\n<div class=\"mediaobject\">\r\n\r\n[caption id=\"attachment_4516\" align=\"aligncenter\" width=\"390\"]<a href=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images-archive-read-only\/wp-content\/uploads\/sites\/1294\/2016\/07\/11194117\/25_031.jpg\" rel=\"attachment wp-att-4516\"><img class=\"size-full wp-image-4516\" src=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images-archive-read-only\/wp-content\/uploads\/sites\/1294\/2016\/07\/11194117\/25_031.jpg\" alt=\"Keynesian view of the AS-AD model shows that with a horizontal AS, a decrease in demand leads to a decrease in output, but no decrease in prices.\" width=\"390\" height=\"233\" \/><\/a> <strong>Figure 1. The Pure Keynesian AD\u2013AS Model. <\/strong>The Keynesian View of the AD\u2013AS Model uses an AS curve which is horizontal at levels of output below potential and vertical at potential output.\u00a0Thus, changes in AD only affect GDP when below potential output, but only affect the price level when at potential output.[\/caption]\r\n\r\n<\/div>\r\n<\/div>\r\n<p class=\"caption\">The pure Keynesian AD-AS model assumes that for any level of GDP below potential, any change in AD affects real GDP, but not the price level. This corresponds to the Keynesian Cross diagram to the left of the Potential GDP line. But to the right of the Potential GDP line, any change in AD affects the price level but not real GDP. This makes sense since potential GDP means all resources are fully employed so it's not possible to produce more output. Thus, any increase in AD can only lead to inflation. Let's redraw the Keynesian Cross diagram to illustrate this (Figure 2). E<sub>p<\/sub> plays the role of aggregate demand, and the income equals expenditure line plays the role of aggregate supply.\u00a0 But once we reach potential GDP, AS becomes vertical, just as it does in the traditional AD-AS model shown in Figure 1.<\/p>\r\n<iframe src=\"https:\/\/h5p.org\/h5p\/embed\/240433\" width=\"1090\" height=\"560\" frameborder=\"0\"><\/iframe>\r\n<strong>Figure 2 (Interactive Graph). The Real Aggregate Supply (RAS) Curve.<\/strong>\r\n\r\nThis version of the Keynesian Cross works exactly like the original version for changes in <span style=\"color: #333333;\">aggregate<\/span> expenditure. But it also allows for positive and negative supply shocks which show up as shifts in real aggregate supply due to changes in resource prices, productivity, etc.\r\n<h2>Supply Shocks<\/h2>\r\nSuppose there is a positive supply shock, for example, an increase in the labor supply. A larger labor supply means the economy can produce more output, so the level of potential GDP (Yp) shifts to the right. As a result, an increase in Ep doesn't cause higher prices since the increased Yp provides room for the economy to grow.\u00a0 Thus, increased Ep leads to increased Y.\u00a0 Of course, if Ep increases enough, the economy would pass Yp and the increased spending would cause inflation, but no additional real GDP.\r\n\r\n<\/div>\r\n<\/div>\r\n<\/div>\r\n<div class=\"textbox tryit\">\r\n<h3>Try It<\/h3>\r\nhttps:\/\/assessments.lumenlearning.com\/assessments\/7576\r\n\r\n<\/div>","rendered":"<div class=\"textbox learning-objectives\">\n<h3>Learning Objectives<\/h3>\n<ul>\n<li>Explain aggregate supply in the income-expenditure model and how the income-expenditure model correlates to the AD-AS model<\/li>\n<\/ul>\n<\/div>\n<p>We observed earlier the income-expenditure model doesn&#8217;t explicitly discuss aggregate supply, but it&#8217;s straightforward to add that, if we think of the aggregate supply curve as answering the question: how do producers respond to a change in aggregate demand?\u00a0Recall Figure 1 below from our earlier discussion of aggregate demand in the Keynesian model. Figure 1 shows the pure Keynesian AD-AS model. Let&#8217;s think about how this corresponds to the income-expenditure model.<\/p>\n<div id=\"post-633\" class=\"post-633 chapter type-chapter status-publish hentry type-1\">\n<div class=\"entry-content\">\n<div id=\"m48750-CNX_Econ_C25_031\" class=\"figure\" title=\"Figure\u00a011.3.\u00a0The Keynesian AS\u2013AD Model\">\n<div class=\"body\">\n<div class=\"mediaobject\">\n<div id=\"attachment_4516\" style=\"width: 400px\" class=\"wp-caption aligncenter\"><a href=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images-archive-read-only\/wp-content\/uploads\/sites\/1294\/2016\/07\/11194117\/25_031.jpg\" rel=\"attachment wp-att-4516\"><img loading=\"lazy\" decoding=\"async\" aria-describedby=\"caption-attachment-4516\" class=\"size-full wp-image-4516\" src=\"https:\/\/s3-us-west-2.amazonaws.com\/courses-images-archive-read-only\/wp-content\/uploads\/sites\/1294\/2016\/07\/11194117\/25_031.jpg\" alt=\"Keynesian view of the AS-AD model shows that with a horizontal AS, a decrease in demand leads to a decrease in output, but no decrease in prices.\" width=\"390\" height=\"233\" \/><\/a><\/p>\n<p id=\"caption-attachment-4516\" class=\"wp-caption-text\"><strong>Figure 1. The Pure Keynesian AD\u2013AS Model. <\/strong>The Keynesian View of the AD\u2013AS Model uses an AS curve which is horizontal at levels of output below potential and vertical at potential output.\u00a0Thus, changes in AD only affect GDP when below potential output, but only affect the price level when at potential output.<\/p>\n<\/div>\n<\/div>\n<\/div>\n<p class=\"caption\">The pure Keynesian AD-AS model assumes that for any level of GDP below potential, any change in AD affects real GDP, but not the price level. This corresponds to the Keynesian Cross diagram to the left of the Potential GDP line. But to the right of the Potential GDP line, any change in AD affects the price level but not real GDP. This makes sense since potential GDP means all resources are fully employed so it&#8217;s not possible to produce more output. Thus, any increase in AD can only lead to inflation. Let&#8217;s redraw the Keynesian Cross diagram to illustrate this (Figure 2). E<sub>p<\/sub> plays the role of aggregate demand, and the income equals expenditure line plays the role of aggregate supply.\u00a0 But once we reach potential GDP, AS becomes vertical, just as it does in the traditional AD-AS model shown in Figure 1.<\/p>\n<p><iframe loading=\"lazy\" src=\"https:\/\/h5p.org\/h5p\/embed\/240433\" width=\"1090\" height=\"560\" frameborder=\"0\"><\/iframe><br \/>\n<strong>Figure 2 (Interactive Graph). The Real Aggregate Supply (RAS) Curve.<\/strong><\/p>\n<p>This version of the Keynesian Cross works exactly like the original version for changes in <span style=\"color: #333333;\">aggregate<\/span> expenditure. But it also allows for positive and negative supply shocks which show up as shifts in real aggregate supply due to changes in resource prices, productivity, etc.<\/p>\n<h2>Supply Shocks<\/h2>\n<p>Suppose there is a positive supply shock, for example, an increase in the labor supply. A larger labor supply means the economy can produce more output, so the level of potential GDP (Yp) shifts to the right. As a result, an increase in Ep doesn&#8217;t cause higher prices since the increased Yp provides room for the economy to grow.\u00a0 Thus, increased Ep leads to increased Y.\u00a0 Of course, if Ep increases enough, the economy would pass Yp and the increased spending would cause inflation, but no additional real GDP.<\/p>\n<\/div>\n<\/div>\n<\/div>\n<div class=\"textbox tryit\">\n<h3>Try It<\/h3>\n<p>\t<iframe id=\"lumen_assessment_7576\" class=\"resizable\" src=\"https:\/\/assessments.lumenlearning.com\/assessments\/load?assessment_id=7576&#38;embed=1&#38;external_user_id=&#38;external_context_id=&#38;iframe_resize_id=lumen_assessment_7576\" frameborder=\"0\" style=\"border:none;width:100%;height:100%;min-height:400px;\"><br \/>\n\t<\/iframe><\/p>\n<\/div>\n\n\t\t\t <section class=\"citations-section\" role=\"contentinfo\">\n\t\t\t <h3>Candela Citations<\/h3>\n\t\t\t\t\t <div>\n\t\t\t\t\t\t <div id=\"citation-list-7657\">\n\t\t\t\t\t\t\t <div class=\"licensing\"><div class=\"license-attribution-dropdown-subheading\">CC licensed content, Shared previously<\/div><ul class=\"citation-list\"><li>The Expenditure-Output Model. <strong>Authored by<\/strong>: OpenStax College. <strong>Located at<\/strong>: <a target=\"_blank\" href=\"https:\/\/cnx.org\/contents\/vEmOH-_p@4.41:2cZ9K6tp@3\/The-Expenditure-Output-Model\">https:\/\/cnx.org\/contents\/vEmOH-_p@4.41:2cZ9K6tp@3\/The-Expenditure-Output-Model<\/a>. <strong>License<\/strong>: <em><a target=\"_blank\" rel=\"license\" href=\"https:\/\/creativecommons.org\/licenses\/by\/4.0\/\">CC BY: Attribution<\/a><\/em>. <strong>License Terms<\/strong>: Download for free at http:\/\/cnx.org\/contents\/bc498e1f-efe9-43a0-8dea-d3569ad09a82@4.4<\/li><\/ul><\/div>\n\t\t\t\t\t\t <\/div>\n\t\t\t\t\t <\/div>\n\t\t\t <\/section>","protected":false},"author":25425,"menu_order":11,"template":"","meta":{"_candela_citation":"[{\"type\":\"cc\",\"description\":\"The Expenditure-Output Model\",\"author\":\"OpenStax College\",\"organization\":\"\",\"url\":\"https:\/\/cnx.org\/contents\/vEmOH-_p@4.41:2cZ9K6tp@3\/The-Expenditure-Output-Model\",\"project\":\"\",\"license\":\"cc-by\",\"license_terms\":\"Download for free at http:\/\/cnx.org\/contents\/bc498e1f-efe9-43a0-8dea-d3569ad09a82@4.4\"}]","CANDELA_OUTCOMES_GUID":"a0428d35-a052-4cfb-85ae-e22a358b8dd8, ef7527ed-62ff-4c1e-9a51-34e2d680f3c6","pb_show_title":"on","pb_short_title":"","pb_subtitle":"","pb_authors":[],"pb_section_license":""},"chapter-type":[],"contributor":[],"license":[],"class_list":["post-7657","chapter","type-chapter","status-publish","hentry"],"part":10308,"_links":{"self":[{"href":"https:\/\/courses.lumenlearning.com\/oldwestbury-wm-macroeconomics\/wp-json\/pressbooks\/v2\/chapters\/7657","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/courses.lumenlearning.com\/oldwestbury-wm-macroeconomics\/wp-json\/pressbooks\/v2\/chapters"}],"about":[{"href":"https:\/\/courses.lumenlearning.com\/oldwestbury-wm-macroeconomics\/wp-json\/wp\/v2\/types\/chapter"}],"author":[{"embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/oldwestbury-wm-macroeconomics\/wp-json\/wp\/v2\/users\/25425"}],"version-history":[{"count":19,"href":"https:\/\/courses.lumenlearning.com\/oldwestbury-wm-macroeconomics\/wp-json\/pressbooks\/v2\/chapters\/7657\/revisions"}],"predecessor-version":[{"id":11361,"href":"https:\/\/courses.lumenlearning.com\/oldwestbury-wm-macroeconomics\/wp-json\/pressbooks\/v2\/chapters\/7657\/revisions\/11361"}],"part":[{"href":"https:\/\/courses.lumenlearning.com\/oldwestbury-wm-macroeconomics\/wp-json\/pressbooks\/v2\/parts\/10308"}],"metadata":[{"href":"https:\/\/courses.lumenlearning.com\/oldwestbury-wm-macroeconomics\/wp-json\/pressbooks\/v2\/chapters\/7657\/metadata\/"}],"wp:attachment":[{"href":"https:\/\/courses.lumenlearning.com\/oldwestbury-wm-macroeconomics\/wp-json\/wp\/v2\/media?parent=7657"}],"wp:term":[{"taxonomy":"chapter-type","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/oldwestbury-wm-macroeconomics\/wp-json\/pressbooks\/v2\/chapter-type?post=7657"},{"taxonomy":"contributor","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/oldwestbury-wm-macroeconomics\/wp-json\/wp\/v2\/contributor?post=7657"},{"taxonomy":"license","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/oldwestbury-wm-macroeconomics\/wp-json\/wp\/v2\/license?post=7657"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}