Notes on Aggregate Demand and Aggregate Supply

Aggregate Demand and Aggregate Supply Model

Definition of Aggregate Demand (AD)
  • AD Curve: Relationship between price level (GDP deflator) and the dollar amount of Real GDP demanded.
  • Sum of All Spending: Includes personal consumption, investment, government spending, and net exports.
  • Inverse Relationship:
    • As price levels fall, spending increases.
    • As price levels rise, spending decreases.
Definition of Aggregate Supply (AS)
  • AS Curve: Shows the short-run relationship between price level and the dollar amount of Real GDP supplied by firms.
  • Influences on Supply: Based on utilization of factors of production (natural resources, labor, capital, entrepreneurship).
  • Direct Relationship:
    • As price levels rise, firms increase output.
    • As price levels decrease, firms reduce output.
Macroeconomic Equilibrium
  • Represents the intersection of the AD and AS curves.
  • Balance Point: Where total expenditure equals total production that firms wish to supply.
Changes in Aggregate Demand and Supply
  • Shift in AD: Results from increased personal consumption, investment, government spending, or net exports which shifts the curve rightward.
  • Shift in AS: Changes in costs of production or productivity shifts the AS curve.
Factors Influencing Personal Consumption Expenditure (PCE)
  • Higher Income: Strong employment, more hours, and higher wages increase household spending.
  • Wealth Factors:
    • Increased home values and stock portfolio gains increase consumer spending.
  • Lower Taxes and Interest Rates:
    • Reduces borrowing costs, encouraging big-ticket purchases and overall spending.
Factors Influencing Investment
  • Higher Profits: Leads to increasing investment in capital and equipment.
  • Lower Interest Rates: Makes borrowing cheaper, encouraging businesses to invest.
  • Business Environment: Favorable conditions reduce uncertainty, lower regulations, and stabilize workforce, promoting investment.
Accelerator Effect
  • Describes the relationship where increases in PCE lead to higher investment due to demand outpacing current capacity.
  • firms invest more in equipment and technology to meet rising demand, triggering further investment in the economy.
Government Spending
  • Increased government expenditure on military and infrastructure boosts aggregate demand.
  • Note: Social security and transfer payments do not directly count as demand as they do not directly increase production but can increase consumption indirectly.
Net Exports
  • Decrease in US Spending Overseas: Higher overseas incomes and lower exchange rates reduce foreign purchases of US goods.
  • Increase in Net Exports: More favorable trading conditions or exchange rates can increase foreign demand for US goods.
Currency Value Influences
  • Exchange Rate Impact: A weaker US dollar increases competitiveness abroad by making exports cheaper for foreign buyers.