krugman_PPT_c16_rev.ppt

Chapter 16 Output and the Exchange Rate in the Short Run Preview Determinants of aggregate demand in the short run A short run model of output market equilibrium A short run model of asset market equilibrium A short run model for both output market equilibrium and asset market equilibrium Effects of temporary and permanent changes in monetary and fiscal policies. Adjustment of the current account over time. IS-LM model Introduction Long run models are useful when all prices of inputs and outputs have time to adjust. In the short run, some prices of inputs and outputs may not have time to adjust, due to labor contracts, costs of adjustment or imperfect information about market demand. This chapter builds on the short run and long models of exchange rates to explain how output is related to exchange rates in the short run. macroeconomic policies affect output, employment and the current account. Determinants of Aggregate Demand Aggregate demand is the aggregate amount of goods and services that people are willing to buy: consumption expenditure investment expenditure government purchases net expenditure by foreigners: the current account Determinants of Aggregate Demand Determinants of consumption expenditure include: Disposable income: income from production (Y) minus taxes (T). More disposable income means more consumption expenditure, but consumption typically increases less than the amount that disposable income increases. Real interest rates may influence the amount of saving and consumption, but we assume that they are relatively unimportant here. Wealth may also influence consumption, but we assume that it is relatively unimportant here. Determinants of Aggregate Demand (cont.) Determinants of the current account include: Real exchange rate: prices of foreign products relative to the prices of domestic products, both measured in domestic currency: EP*/P As the prices of foreign products rise relative to those of domestic products, expenditure on domestic pr