Aggregate Demand/Aggregate Supply Model Summary

Housing Market Overview

  • Homeownership in the U.S. increased from 64% (1990) to over 69% (2004-2005).

  • Mortgage values tripled during this period, making housing accessible and viewed as safe investments.

  • Peak new home sales occurred in 2005 (107,000 units).

Housing Bubble and Bust

  • Signs of the bubble bursting began in 2005 with rising delinquencies and oversupply.

  • Declining home values led to reduced household wealth and decreased consumer spending.

  • Mortgage lender bankruptcies occurred, leading to a credit crisis by 2008.

  • The housing crisis contributed to the Great Recession, causing unemployment over 10% and falling GDP.

  • Recovery efforts involved aggressive fiscal and monetary policies.

Economic Fluctuations

  • U.S. economy follows a cyclical pattern with periods of recession and expansion.

  • Aggregate demand-aggregate supply (AD-AS) model is introduced to analyze economic growth cycles.

Aggregate Demand and Supply Model Overview

  • The model helps analyze macroeconomic issues including growth, unemployment, and inflation.

  • Say's Law: "Supply creates its own demand"; applies in the long run but struggles to explain recessions.

  • Keynes' Law: "Demand creates its own supply"; better describes the economy in the short run, especially during recessions.

Aggregate Supply (AS) and Aggregate Demand (AD)

  • AS Curve: Represents total quantity of output (real GDP) firms supply at varying price levels, slopes upward.

  • Potential GDP: Maximum production with full employment; AS can temporarily exceed this in the short run.

  • AD Curve: Total spending determined by consumption, investment, government spending, and net exports; slopes downward due to wealth effect, interest rate effect, and foreign price effect.

Macroeconomic Equilibrium

  • The interaction of AS and AD determines equilibrium price level and real GDP.

  • Equilibrium occurs where AD equals AS, leading to stable economic conditions or indicating unemployment/inflation based on AS slope.

Shifts in AS and AD

  • AS Shift Factors: Productivity growth and input prices.

  • AD Shift Factors: Consumer/business confidence, government policies, and tax changes.

  • AD shifts right (increased spending) or left (decreased spending) impact GDP and price levels significantly.

Employment and Inflation in AD-AS Model

  • Economic growth pushes equilibrium toward potential GDP; recessions create significant gaps where GDP is below potential.

  • Cyclical unemployment correlates with short-run GDP fluctuations; government interventions aim to stabilize AD to close recessionary gaps.