Chapter 29: Aggregate Demand and Aggregate Supply

Aggregate demand-aggregate supply model

Provides keen insights on inflation, recession, and unemployment

Aggregate demand

A schedule or curve that shows the amounts of real output (real GDP) that buyers collectively desire to purchase at each possible price level

Real-balances effect

Higher price level reduces purchasing power + results in less consumption spending

Interest-rate effect

Higher price level increases demand for money

Foreign purchases effect

When the U.S. price level rises relative to foreign price levels (and exchange rates do not respond quickly or completely), foreigners buy fewer U.S. goods and Americans buy more foreign goods

Determinants of aggregate demand

Factors that can shift the entire aggregate demand curve

Aggregate supply

A schedule or curve showing the relationship between the price level and the amount of real domestic output that firms in the economy produce

Immediate short run aggregate supply curve

Calculated from all of the individual prices set by the various firms in the economy; horizontal shape implies that the total amount of output supplied in the economy depends directly on the volume of spending

Short run aggregate supply curve

Slopes upward because, with input prices fixed, changes in the price level will raise or lower real firm profits

Long run aggregate supply curve

Vertical at economy’s full employment output; in the long run the economy will produce the full-employment output level no matter what the price level is

Determinants of aggregate supply

Shift the aggregate supply curve when they change

Productivity

A measure of the relationship between a nation’s level of real output and the amount of resources used to produce that output

Equilibrium price level and output

Established by the intersection of the aggregate demand curve AD and the aggregate supply curve AS

Menu costs

Firms that think a recession will be relatively short-lived may be reluctant to cut their prices

Efficiency wages

Wages that elicit maximum work effort and thus minimize labor costs per unit of output

price level

When the ________ rises, the quantity of real GDP demanded decreases; when the ________ falls, the quantity of real GDP demanded increases.

Aggregate demand-aggregate supply model

Provides keen insights on inflation, recession, and unemployment

Aggregate demand

A schedule or curve that shows the amounts of real output (real GDP) that buyers collectively desire to purchase at each possible price level

Real-balances effect

Higher price level reduces purchasing power + results in less consumption spending

Interest-rate effect

Higher price level increases demand for money

Foreign purchases effect

When the U.S. price level rises relative to foreign price levels (and exchange rates do not respond quickly or completely), foreigners buy fewer U.S. goods and Americans buy more foreign goods

Determinants of aggregate demand

Factors that can shift the entire aggregate demand curve

Consumer spending

If those consumers decide to buy more output at each price level, the aggregate demand curve will shift to the right (and vice versa)

Investment spending

A decline in investment spending at each price level will shift the aggregate demand curve to the left (and vice versa)

Government spending

An increase in government purchases (for example, more military equipment) will shift the aggregate demand curve to the right (and vice versa)

Net export spending

A rise in net exports (higher exports relative to imports) shifts the aggregate demand curve to the right (and vice versa)

Aggregate supply

A schedule or curve showing the relationship between the price level and the amount of real domestic output that firms in the economy produce

Immediate short run aggregate supply curve

Calculated from all of the individual prices set by the various firms in the economy; horizontal shape implies that the total amount of output supplied in the economy depends directly on the volume of spending

Short run aggregate supply curve

Slopes upward because, with input prices fixed, changes in the price level will raise or lower real firm profits

Long run aggregate supply curve

Vertical at economys full employment output; in the long run the economy will produce the full-employment output level no matter what the price level is

Determinants of aggregate supply

Shift the aggregate supply curve when they change

Productivity

A measure of the relationship between a nations level of real output and the amount of resources used to produce that output

Equilibrium price level and output

Established by the intersection of the aggregate demand curve AD and the aggregate supply curve AS

Menu costs

Firms that think a recession will be relatively short-lived may be reluctant to cut their prices

Efficiency wages

Wages that elicit maximum work effort and thus minimize labor costs per unit of output