AP Econ: chapter 20

Aggregate Demand – shows the level of RGDP purchased by households, businesses, government, and foreigners at different possible price levels

There are 3 main reasons why the AD curve is downward sloping.

  1. Real Balances or Wealth Effect - At higher price levels we have less purchasing power / feel less wealthy and demand a lower quantity of goods and services. At lower price levels we have more purchasing power / feel more wealthy and demand a higher quantity of goods and services.

  2. Interest Rate Effect – At higher price levels, banks must charge higher interest rates on loans so fewer loans are taken out thus less quantity demanded of goods and services. At lower price levels, banks can charge lower interest rates on loans so more loans are taken out thus more quantity demanded of goods and services. r = interest rates

  3. Net Export / Foreign Purchases Effect- At higher price levels, foreigners are less interested in our exports thus less quantity demanded of goods and services. At lower price levels, foreigners are more interested in our exports thus more quantity demanded of goods and services. The AD shifts RIGHT – when C, I G or (X-M) increase - it is an increase in AD The AD shifts LEFT – when C, I G or (X-M) decrease –it is a decrease in AD

Aggregate Supply – shows the level of RGDP produced at different price levels

There are 3 ranges to the Aggregate Supply curve – each telling what is going on in the economy.

  1. Keynesian Range – Prices (P), wages(W), and interest rates(r )are fixed – shown by the unchanging P/L. We only draw the AD in this range when the economy is in a recession – 2 consecutive quarters or more of negative RGDP

  2. Intermediate-Range – more in line with the typical upward-sloping Supply curve we are used to. We spend most of our time in this range – we are working towards full employment, but not there yet

  3. Classical Range - The belief is Prices, wages, and interest rates are flexible and adjust and any downturn in the economy will be of short duration. The economy will correct and get back to full employment. We are only in this range if we are at FULL EMPLOYMENT – 4% to low %5 unemployment.

The AS shifts RIGHT - it is an increase in AS – based on the ability to produce and the cost of production

The AS shifts LEFT - it is a decrease in AS – based on the ability to produce and the cost of production

  • Ability to produce and cost of production could include: Resource prices, technological changes/ abilities, taxes, subsidies, regulations

Remember that a federal fund rate or any interest rate is r so that means when r decreases, people will have more money to spend but when it increases, people will have less money to spend

  • To help in the case of STAGFLATION you have to increase the aggregate supply curve- this is the only way to help stagflation