Aggregate Demand and Aggregate Supply

Flashcards reviewing Aggregate Demand and Aggregate Supply concepts.

Aggregate Demand

The total amounts of goods and services that will be purchased at all possible price levels.

Aggregate Demand Components

The sum of consumption, investment, government expenditure, and net exports. [AD = C + I + G + (X-M)]

Interest Rates Effect on Aggregate Demand

Affect decisions made by consumers and businesses; Lower rates lower borrowing costs, leading to capital spending increases; higher rates increase borrowing costs, slowing spending.

Income and Wealth Effect on Aggregate Demand

As household wealth increases, aggregate demand usually increases, and vice versa.

Changes in Inflation Expectations Effect on Aggregate Demand

Consumers anticipating inflation tend to make purchases now, increasing aggregate demand; expectations of falling prices decrease aggregate demand.

Currency Exchange Rate Changes Effect on Aggregate Demand

If the U.S. dollar falls, foreign goods become more expensive, and U.S. goods become cheaper for foreign markets, increasing aggregate demand (and vice versa).

Aggregate Supply

The total amount of goods and services that firms are willing to sell at a given price in an economy.

Short Run Aggregate Supply

The total supply of goods and services currently being achieved in the economy.

Long Run Aggregate Supply

The maximum supply of goods and services that can be achieved with full employment of resources.

Productivity Effect on Short-Run Aggregate Supply

Higher productivity decreases unit costs of production, increasing aggregate supply.

Labor Wage Costs Effect on Short-Run Aggregate Supply

Higher wage costs increase costs of production, decreasing aggregate supply.

Material Prices Effect on Short-Run Aggregate Supply

Increase the unit labor costs of production and lower aggregate supply.

Taxes and other costs Effect on Short-Run Aggregate Supply

Regulation and taxation costs can place a burden on the unit costs of production, lowering the aggregate supply of an economy.

Say’s Law

States that supply creates its own demand; the key to economic growth is increasing production.

Macroeconomics of Supply

Suggests the key to economic growth is not increasing demand, but increasing production, which will generate enough income to purchase all output.

Keyne’s Law

Demand creates its own supply; recessions are caused by a lack of demand, leading to inadequate incentives for firms to produce.

Aggregate Demand Curve

Shows how GDP relates to price levels; quantitatively, aggregate demand and GDP are the same over the long-term.

Aggregate Demand Curve Definition

A curve that shows the negative relationship between aggregate output (income) and the price level.

Real Wealth Effect

A change in the price level changes the purchasing power of assets, causing consumers to buy more (or less) goods and services.

Interest Rate Effect

A change in price level changes the amount of savings in the economy, which changes interest rate, leading to a change in borrowing and investment.

Exchange Rate Effect

A change in price level changes the amount that people from other countries are willing and able to purchase.

Equilibrium in the Aggregate Demand/Aggregate Supply Model

Occurs when aggregate supply (AS) equals aggregate demand (AD), determining the equilibrium level of real GDP and the equilibrium price level in the economy.

Growth and Recession in the AD/AS Diagram

Long-run economic growth is represented by a gradual shift to the right of aggregate supply; short run GDP falls and rises with recessions and expansions.

Unemployment in the AD/AS Diagram

Variations are caused by the business cycle; the level that occurs year-in and year-out is called the natural rate of unemployment.

AD/AS Diagram on Unemployment

Shows cyclical unemployment by how close the economy is to the potential or full GDP employment level.

Sources of Inflationary Pressure in the AD/AS Model

When aggregate demand shifts to the right near potential GDP or a rise in input prices causes the aggregate supply curve to shift back to the left.