Aggregate Demand and Supply

Aggregate Demand

A schedule or curve that represents the relationship between the quantity of real GDP demaned in the economy and the price level, all else held constant.

Quantity of Real GDP Demanded

The aggregate quantity of output at a given price level.

Macroeconomic importance of unemployment and inflation relates directly to…

Economic growth, Output, and Standards of Living

What is Aggregate Demand about?

Overall or total demand for all final goods and services produced in an economy.

Aggregate Demand models need…

Aggregate price (like price indexes)

The Aggregate Demand curve is ___ sloping

Downward

The downward slope of the Aggregate Demand Curve represents…

The negative relationship between the price level and quantity of real gdp demanded.

Aggregate Expenditures determine…

The level of real GDP

Aggregate Demand relates…

The price level to real GDP

Higher prices reduce…

Exports

Higher prices stimulate…

Imports

When Gross Investment increases, Aggregate Expenditures Schedule shifts ____ and Aggregate Demand Curve shifts to the ____

Upward; Right and real GDP increases

Real Balances Effect

When the price level rises, the real value of savings falls and people are less willing or able to buy goods and services, thus reducing the aggregate quantity of real GDP demanded.

Interest Rate Effect

When the price level rises, the demand for money increases, which causes interest rates to rise, resulting in a decrease in investment and consumption spending, thus reducing the aggregate quantity of real GDP.

Foreign Purchases Effect

When the price level rises, the quantity of exports decreases and the quantity of imports increases, resulting in a decrease in net exports, thus reducing the aggregate quantity of real GDP demanded.

3 reasons why the Aggregate Demand Curve slopes downward:

• Real balances effect

• Interest rate effect

• Foreign purchases effect

Diminishing Marginal Utility

The negative relationship between the quantity of a good, service, or resource and the marginal utility obtained from each additional unit consumed in a given period of time.

Income Effect

The effect that a change in the price of a good, service, or resource has on the purchasing power of income.

Substitution Effect

The effect that a change in the price of a good, service, or resource has on the demand for another.

Increase in Aggregate Demand and Supply Graphically

Rightward Shift

Decrease in Aggregate Demand and Suppy Graphically

Leftward Shift

Changes In _____, _____, _____, and _____ can affect the aggregate demand curve.

• Consumer wealth

• Borrowing

• Taxes

• Expectations

Rising wealth, increased borrowing, lower personal taxes, and improved consumer expectations will all cause…

Consumption to rise and the aggregate demand curve to shift to the right.

When a determinant of consumption or gross investment changes…

The aggregate demand curve shifts.

Exchange Rate

The rate, or price, at which one currency can be exchanged for another.

Appreciation

An increase in the value, or price, of one currency relative to another.

Depreciation

A decrease in the value, or price, of one currency relative to another.

If either government purchases or net exports increase…

Aggregate demand will increase.

2 Main Determinants of Net Exports:

• Exchange Rates

• National Income Levels

If incomes rise in foreign countries…

US exports will rise and increase net exports.

If incomes fall in foreign countries…

US exports will decrease and net exports will fall

If incomes increase in the US…

US imports will rise and net exports will fall

If incomes in the US fall…

US imports fall and increase net exports.

Aggregate Supply

A schedule or curve that represents the relationship between the quantity of real GDP supplied in the economy and the price level.

Sticky Wages:

A situation where wages do not adjust in the short run.

In the short run, the aggregate supply curve slopes…

Upward.

Input prices in the short run are…

Fixed

Productivity

The total amount of output produced with a given level of inputs.

Resource Price

The price paid for, or opportunity cost of, using a resource such as land, labor, capital, or entrepreneurial ability.

Social Institutions

The formal and informal rules of the game that society creates to provide structure to political, economic, and social interactions.

The determinantes of aggregate supply fall into three broad categories;

-Productivity

-Resource prices

-Social institutions

Long run Aggregate Supply:

The relationship between real GDP and the price level when all input prices are flexible.

LRAS Graphically

A vertical line at the full employment of real GDP.

Sticky Resource Prices

The idea that resource prices tend to adjust slowly in response to changes in the market.

Flexible Prices

The idea that in the long run resource prices are able to fully adjust to changes in the market.

Long Run

The time period in which all inputs of production can be changed

Short Run

The time period in which at least one input of production is fixed, but other inputs can be changed.

In the long run (when price level increases, cuts back labor):

• Firms compete

• Workers demand raises

• Wages rise

• Output falls

In the long run (when price level falls, hires more labor)

• Workers compete

• Labor costs fall

• Output increases

Short-run equilibrium

A short run situation in which aggregate quantity of real GDP demanded is equal to the aggregate quantity of real GDP supplied.

Recession

A decline in real output for at least two consecutive quarters.

Expansion

A phase of the business cycle characterized by increasing real GDP, income, and employment.

Business cycle

The short-term fluctuations experienced in the economy due to. changes in economy activity.

Depression

A long-lasting and severe recession.

Trough

The lowest point of economic activity in the business cycle, where real GDP reaches a minimum. The trough marks the end of a recession.

Peak

A point in the business cycle where real GDP reaches a maximum. The peak marks the end of expansion.

Demand-pull inflation

Inflation that occurs due to an increase in aggregate demand.

Cost-push inflation

Inflation that occurs due to a decrease in aggregate supply.

Stagflation

When an economy simultaneously experiences both a rise in unemployment (a stagnating economy) and a rise in price (inflation).

Phillips curve

The downward-sloping line that represents the negative or inverse relationship between the rate of inflation and the unemployment rate in the short run.

Unemployment rate

The percentage of workers in the labor force who are unemployed; a good indicator of the overall health of the economy.

Inflation rate

The percentage change in the overall price of goods and services in the economy from one time period to another.

Y* =

Full employment level of output

Pe =

equilibrium price level

The short-run equilibrium occurs where…

The AD and AS curves intersect, crossing at the full-employment level of output.

What does it mean for the output and unemployment if the AD and AS intersect to the left of LRAS?

Output is lower than the full-employment level and the unemployment rate is higher than the natural rate of unemployment.

What does it mean for the output and unemployment if the AD and AS intersect to the left of LRAS?

Output is below the full-employment level and the unemployment rate is lower than the natural rate of unemployment.

More workers means more…

production

It is the ____ that adjusts, in the long run, to return the economy to its long-run equilibrium

Aggregate supply

What is the primary mechanism that causes aggregate supply to adjust in the long run?

Resource costs like wages.

Increased AD (like from increased government purchases) results in…

Higher output and higher prices

Decreased AD (like from increase in resource costs) results in…

lower output and higher prices

How is stagflation represented in the AD-AS model?

A decrease in AS

Positive Shock to Aggregate Demand or Increased Output causes

Increases inflation and lowers unemployment

Negative Shock to Aggregate Demand or Decreased Output causes

Decreases inflation and raises unemployment