IB Economics - 3.2

Aggregate Demand

The total demand for all goods/services in an economy at any given average price level.

C + I + G + (X-M) (the value of each component can vary between different countries)

Increase in AD = Economic growth

AD Curve

Similar to normal demand curve

- Downward sloping

- Movement along is due to changes in price level

Shifts in AD curve

Due to changes in determinants of AD

C: Consumer confidence, interest rates, wealth, income taxes, level of debt, expectations of future price levels.

I: Interest rates, business confidence, technology, business taxes, level of debt.

G: Political priorities, Economic priorities

(X-M): Income of trading partners, exchange rates, trade policies

Aggregate Supply

The total supply of goods/services produced within an economy at a specific price level at a given time

SRAS Curve

Similar to a supply curve

Movements are due to changes in average price level

Shifts are due to non-price factors

Non-price determinants of SRAS

Changes in wages

Changes in non-labour resource prices

Changes in indirect taxes

Changes in subsidies offered to firms

Supply shocks

Monetarist View of LRAS

Perfectly inelastic at point of full employment

In the long-run an economy will always return to the full employment level of output

During inflationary and deflationary gaps, they believe the economy will self-correct and return to the long-run level of output but at higher or lower price levels.

Keynesian view of AS

3 sections:

1. Elastic section: due to spare capacity in the economy, firms will increase output without raising prices

2. Relatively-price elastic section: firms start to bid with each other for available resources and price levels begin to rise

3. Perfectly-inelastic section: Full employment of all available resources. More inflation as firms compete for resources

The economy will not always self-correct and return to full employment level of output and can get stuck at an equilibrium below the full employment level. This is because of FoP Cost inflexibility, such as sticky wages.

Also believes govt expenditure can shift Aggregate Demand

Output Gap

Difference between actual level of output and the maximum potential level of output

Can be difficult to measure because it is difficult to know the maximum productive potential of an economy.

Inflationary Gap

Real GDP > Potential Real GDP

Deflationary Gap

Potential Real GDP > Real GDP

Spare capacity exists

Factors that shift the LRAS

Changes in the quantity or quality of factors of production (technology, efficiency)

Changes in institutions