Aggregate Supply and Demand

Aggregate Supply and Aggregate Demand

The discussion revolves around aggregate supply and aggregate demand, starting with aggregate demand.
It's emphasized that aggregate demand and supply are similar to traditional supply and demand but with significant differences when viewed in a macroeconomic context.

Microeconomics focuses on specific markets, such as the market for candy bars.
The vertical axis represents the price per unit of the candy bar, while the horizontal axis represents the quantity bought or sold.
Demand curves are typically downward sloping.
Interpretation of Demand Curve:
- At high prices, consumers opt for alternatives, reducing the quantity demanded.
- At low prices, candy bars become more attractive, increasing the quantity demanded.
- Alternatively, the curve can be viewed as a marginal benefit curve, with high willingness to pay for initial units and decreasing benefit for subsequent units.

Aggregate demand considers the economy as a whole, not just a single market.
The horizontal axis represents real GDP (the actual production of the economy).
The vertical axis represents the general price level in the economy.
The aggregate demand curve is also downward sloping.
If prices are high, GDP contracts; if prices are low, GDP expands (ceteris paribus).
This is distinct from the substitution effect seen in microeconomics.

Demand: Concerns one product, good, or service.
Aggregate Demand: Concerns the economy as a whole, reflecting the actual productivity of the economy.

Assumes only prices change, while other factors remain constant (ceteris paribus).
If prices decrease, consumers feel wealthier because their money can buy more, leading to increased demand.
If prices increase, consumers feel less wealthy and demand fewer goods and services.

If prices decrease, consumers can spend less on goods and services, leading to increased savings.
Increased savings increase the supply of money for lending, reducing interest rates.
Lower interest rates stimulate investment, causing the economy to expand.
Conversely, if prices increase, savings decrease, leading to higher interest rates and economic contraction.
- Prices \downarrow \implies Savings \uparrow \implies Money_Supply \uparrow \implies Interest_Rates \downarrow \implies Investment \uparrow \implies Real_GDP \uparrow
- Prices \uparrow \implies Savings \downarrow \implies Money_Supply \downarrow \implies Interest_Rates \uparrow \implies Investment \downarrow \implies Real_GDP \downarrow

If prices decrease, interest rates decrease, prompting investors to convert currency to those with higher interest rates.
This weakens the currency, making domestic goods and services cheaper for foreign buyers and increasing net exports.
Increased net exports lead to GDP expansion.
Alternatively, lower price levels in a country attract foreign consumers, increasing net exports.
If prices decrease, interest rates decrease, leading to currency conversion and a weaker dollar.
- Prices \downarrow \implies Interest_Rates \downarrow \implies Currency_Conversion \implies Dollar_Weakens \implies Exports \uparrow \implies Real_GDP \uparrow
Example: If a car costs $10,000 in the US, and the dollar weakens, the cost in pounds sterling decreases, enticing foreign consumers to buy American cars.