Aggregate Demand and Aggregate Supply

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• Aggregate Demand and Aggregate Supply
• Read Chapter 7 pages 145-165
• I Aggregate Demand
• A) Basic definitions
• Aggregate demand is the relationship between the
  total quantity of goods and services demanded and
  the price level, all other determinants of
  spending unchanged.
• 2) The aggregate demand curve is a graphical
  representation of aggregate demand.

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• B) The slope of the aggregate demand curve is
  negative. This reflects the following effects.
• The wealth effect is the tendency for a change in
  the price level to affect real wealth and thus
  alter consumption.
• The interest rate effect is the tendency for a
  change in the price level to affect the interest
  rate and thus the quantity of investment
  demanded.
• 3) The international trade effect is the
  tendency for a change in the price level to
  affect net exports.

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• C) Change in the quantity demanded versus a
  change in demand
• A movement along an aggregate demand curve is a
  change in the aggregate quantity of goods and
  services demanded.
• 2) A change in the aggregate quantity of goods
  and services demanded at every price level is a
  change in aggregate demand.

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• D) Factors that can change aggregate demand.
• Changes due to consumption
• Consumer confidence.
• Tax and transfer policy.
• 2) Changes due to investment
• Expectations about profits for firms.
• b) Changes in interest rates due to things other
  than a change in the general price level. (I.e.
  not the same as the interest rate effect.)

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• 3) Changes in government purchases.
• 4) Changes in exports.
• Change in a foreign countries income
• Change in the exchange rate.
• A countries exchange rate is the price of
  its currency in terms of another currency or
  currencies, e.g. yen/. A rise in the exchange
  rate makes U.S. goods more expensive and fewer
  are purchased.

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• E) The multiplier
• The multiplier is the ratio of the change in the
  quantity of real GDP demanded at each price
  level to the initial change in one or more
  components of aggregate demand that produce it.
• Multiplier
• change in real demand / initial change in
  demand component
• 3) The multiplier occurs due to a domino effect.

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• II Aggregate Demand and Aggregate Supply
• Basics of the long run and the short run.
• The short run in macroeconomic analysis is a
  period in which wages and some other prices do
  not respond to changes in economic conditions.
• 2) A sticky price is a price that is slow to
  adjust to its equilibrium level, creating
  sustained periods of shortage or surplus.
• 3) The long run in macroeconomic analysis is a
  period in which wages and prices are flexible.

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• B) The long run
• The long-run aggregate supply (LRAS) curve
  relates the level of output produced by firms to
  the price level in the long run.
• This curve is vertical at the economys potential
  output level.
• 3) Note, although there is a single real wage
  that clears the labor market, the price level and
  the nominal wage rate can take a range of values.

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• 3) The long run equilibrium occurs where the long
  run aggregate supply and the aggregate demand
  curves intersect.

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• C) The Short Run
• The short-run aggregate supply (SRAS) curve is a
  graphical representation of the relationship
  between production and the price level in the
  short run.
• 2) Factors held constant in the short run
• Capital stock.
• Stock of natural resources.
• Level of technology.
• d) Prices of factors of production.

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• 3) A change in the price level produces a change
  in the aggregate quantity of goods and services
  supplied and is illustrated by the movement along
  the short-run aggregate supply curve.
• 4) A change in the quantity of goods and services
  supplied at every price level in the short run is
  a change in short-run aggregate supply.

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• D) Reasons for Wage and Price Stickiness
• Wage Stickiness due to
• labor contracts
• minimum wages.
• 2) Price Stickiness due to
• induced from labor stickiness
• reluctance by a firm to jeopardize customer
  relations
• c) long term contracts.

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• E) Equilibrium Levels of Price and Output in the
  short run.
• Two examples
• 1) A change in health care costs.

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• 2) A change in government purchases.

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• III Recessionary and Inflationary Gaps and the
  Achievement of Long-Run Macroeconomic Equilibrium
• Terminology
• The gap between the level of real GDP and
  potential output, when real GDP is less than
  potential, is called a recessionary gap.
• 2) The gap between the level of real GDP and
  potential output, when real GDP is greater than
  potential, is called an inflationary gap.

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• B) Restoring Long Run Macroeconomic Equilibrium
• 1) An increase in Aggregate Demand.
• a) Consider an economy initially at long run
  equilibrium given by subscripts of 1.
• b) Next, suppose government spending increases.

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• 2) A decrease in Aggregate Supply
• Consider an economy initially at long run
  equilibrium given by subscripts of 1.
• b) Next, suppose that health care costs rise.

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• C) Gaps and Public Policy
• A nonintervention policy is one in which there is
  no policy choice taken to try to close a
  recessionary or an inflationary gap.
• 2) A stabilization policy is one in which a
  policy choice is taken in an attempt to move the
  economy to its potential output.
• 3) A stabilization policy designed to increase
  real GDP is known as expansionary policy.
• 4) A stabilization policy designed to reduce real
  GDP is a contractionary policy.

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• 5) Fiscal policy is the use of government
  purchases, transfer payments and taxes to
  influence the level of economic activity.
• 6) Monetary policy is the use of central bank
  policies to influence the level of economic
  activity.

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