Aggregate Supply, Aggregate Demand and Unemployment

1
Aggregate Supply, Aggregate Demand and
Unemployment

• Week 4
• Professor Dermot McAleese

2
AS CURVE
The Aggregate Supply (AS) curve is an equilibrium
locus showing combinations of real GDP (y) and
the price level (p) consistent with profit
maximising firms (who equate wage with marginal
product of employees) and utility maximising
individuals (who decide how much work to supply
in response to changes in real wage and who do
not suffer from money illusion).
AS
Price P
E0
P0
0
Y0
Output Y
3
EQUILIBRIUM IN THE LABOUR MARKET
Sl
Real wage w/p
w/p
Dl
L
Quantity of labour
Real output y
y A.f(L,K)
Quantity of labour
L
4
AS curve is vertical in the long run

• but it can be positive-sloped in the short run
  because of money illusion, wage rigidities,
  employment contracts and price rigidities

5
SHIFTS IN THE AS CURVE

• an increase in investment
• an increase in labour supply because of
  immigration, higher labour participation rate
• advances in technology
• better economic policy lower unemployment rate,
  more entrepreneurial business environment, lower
  taxes

6
CAUSES OF UNEMPLOYMENT A PRELIMINARY VIEW

• Minimum Wage
• Trade union power
• Tax wedge
• Hysteresis
• See CHAPTER 14 and CHAPTER 10 for further
  details

7
AD CURVE
The aggregate demand (AD) curve shows the
relationship between real GDP (y),and the price
level (p) consistent with equilibrium in the
money market
Price P
E0
P0
E1
P1
AD
0
Y0
Y1
Output Y
8
SHIFTS IN THE AD CURVE

• an upsurge in business expectations leads to
  higher investment
• consumers decide to increase their spending
• peoples preferences for holding money change
• the monetary authorities increase the money
  supply

9
AD AS at E
AD national spending national income
national output AS
Price (P)
AS
P2
E
P0
P1
AD
0
Output (Y)
Y1
Y0
Y2