Aggregate Demand and Aggregate Supply

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• Aggregate Demand and Aggregate Supply

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The Aggregate Demand Curve

• When price level rises, money demand curve shifts
  rightward
• Consequently, interest rate is higher, given
  money supply is fixed
• Then, aggregate expenditure decreases (AE line
  shifts downward)
• As a result, the equilibrium GDP becomes lower
• So,
• a rise in price level causes a decrease in
  equilibrium GDP.
• The aggregate demand curve shows the
  negative relationship between price levels and
  equilibrium real GDP

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Figure 1 Deriving the Aggregate Demand Curve
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Understanding the AD Curve

• Each point on the AD curve represents a short-run
  equilibrium in economy
• The AD curve is different from a demand curve for
  one particular product

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Movements of the AD Curve

• Moving along the AD curve whenever price level
  changes
• When anything other than price level cause
  equilibrium GDP to change, the AD curve shifts
• Government purchasing
• Taxes
• Autonomous consumption spending
• Investment spending
• Net exports
• Money supply
• Expectations

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Figure 2 A Spending Shock Shifts the AD Curve
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Costs and Prices

• To understand how macroeconomic events affect the
  price level, we assume
• A firm sets price of its products as a markup
  over cost per unit
• So, in the short-run, price level rises when
  there is an economy-wide increase in unit costs
• Labor costs
• Costs of natural resources
• How an increase in output level raises the price
  level?
• As output increases, demand for inputs rises
• As unit cost increases, price level ( assumed as
  a markup over unit cost) rises

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Figure 3 The Aggregate Supply Curve
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Movements of the AS Curve

• When price level changes due to a change in real
  GDP, the change happens along the AS curve
• When the change of price level is caused by any
  factor other than real GDP, the AS curve shifts
• Oil prices
• Weather
• Technological change
• Nominal wage

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Figure 4 Shifts of the Aggregate Supply Curve
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Figure 5 Short-Run Macroeconomic Equilibrium
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Figure 6 The Effect of a Demand Shock
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An Increase in Government Purchases

• When G , AD curve shifts rightward. As a
  result, real GDP , given price level is fixed
• However, when real GDP , unit cost , so price
  level
• Furthermore, as price level , Md and interest
  rate , which causes aggregate expenditure to
  decrease
• In the end, real GDP increases by less than
  horizontal shift in AD curve

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An Increase in the Money Supply

• Can you demonstrate how an increase in the money
  supply affects the real equilibrium GDP?

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Demand Shocks

• A positive demand shockshifts AD curve rightward
• Increases both real GDP and price level in
  short-run
• A negative demand shockshifts AD curve leftward
• Reduces both real GDP and price level in short-run

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Examples

• The Great Depression 1929 1933
• Negative demand shocks
• Oil Crisis 1973 (began on October 17)
• Negative supply shocks

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Demand Shocks Adjusting to the Long-Run

• In short-run, wage rate is treated as given
• But in long-run, wage rate can change
• When output is above full employment, wage rate
  will rise, shifting AS curve upward
• When output is below full employment, wage rate
  will fall, shifting AS curve downward

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Figure 7 The Long-Run Adjustment Process After
A Positive Demand Shock
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Figure 8 Long-Run Adjustment After A Negative
Demand Shock
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Figure 9 The Effect of a Supply Shock
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More examples

• 1990-91 recession
• Oil supplies and price of oil
• 2001 recession
• Money supply and interest rate

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Inflation and Unemployment

• Low inflation and unemployment
• Feds major goals
• Compatible or conflicting?
• Short-run tradeoff
• Supply shocks cause both rates to rise
• No long-run tradeoff

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The Phillips Curve
AS
P3
Price Level
P2
AD3
P1
AD2
P0
AD1
AD0
0
Q0
Q1
Q2
Q3
Real Domestic Output
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The Phillips Curve

• Demonstrates short-run tradeoff between inflation
  and unemployment

Concept
Empirical Data Data for the 1960s
69
68
66
67
65
63
62
61
64
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The Phillips Curve

• No long-run tradeoff between inflation and
  unemployment
• Short-run Phillips curve
• Role of expected inflation
• Long-run vertical Phillips curve
• Disinflation vs. Reflation

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The Long Run Phillips Curve
PCLR
PC3
b3
PC2
a3
Annual Rate of Inflation (Percent)
b2
PC1
a2
c3
b1
a1
c2
0
Unemployment Rate (Percent)