Ib macroeconomics SL - aggregate demand and supply , 3.2

Aggregate demand (AD)

The total quantity of goods and services demanded in an economy at different average price levels in a given time period. AD = C + I + G + (X − M).

Aggregate demand curve

A curve showing the relationship between the average price level and the level of planned expenditure in an economy.

Components of AD

The four components are consumption (C), investment (I), government spending (G), and net exports (X − M).

Consumption (C)

Spending by households on goods and services.

Investment (I)

Spending by firms on capital goods such as machinery, factories, and equipment.

Government spending (G)

Expenditure by the government on goods and services.

Net exports (X − M)

The value of exports minus the value of imports.

Aggregate supply (AS)

The total quantity of goods and services that firms in an economy are willing and able to produce at different average price levels in a given time period.

Short-run aggregate supply (SRAS)

The relationship between the price level and the quantity of output firms are willing to produce in the short run, assuming resource prices are constant.

Long-run aggregate supply (LRAS)

The relationship between the price level and the quantity of output when all resource prices (including wages) are variable. In the long run, LRAS is vertical at the full-employment level of output.

Keynesian aggregate supply curve

A model of aggregate supply that is flat at low levels of output (indicating spare capacity) and becomes vertical at the full-employment level of output.

New classical (monetarist) aggregate supply curve

A model of aggregate supply that is vertical at the full-employment level of output, based on the idea that wages and prices are flexible.

Equilibrium level of real GDP

The level of output where aggregate demand equals aggregate supply.

Deflationary (recessionary) gap

Occurs when equilibrium real GDP is less than potential GDP, due to insufficient aggregate demand.

Inflationary gap

Occurs when equilibrium real GDP is greater than potential GDP, due to excessive aggregate demand.

Full employment equilibrium

When aggregate demand intersects aggregate supply at the potential level of output.

Multiplier effect

The idea that an increase in spending leads to a larger increase in national income due to successive rounds of re-spending.

Marginal propensity to consume (MPC)

The fraction of additional income that households spend on consumption.

Marginal propensity to save (MPS)

The fraction of additional income that households save rather than spend.

Multiplier formula

1 / (MPS + MPM + MRT) or 1 / (1 − MPC).