Road Map

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Chapter 13Aggregate Demand, Aggregate Supply,
and Inflation
Road Map
1. The Aggregate Demand (AD) Curve2. The
Aggregate Supply (AS) Curve3. The Equilibrium
Price Level (P)4. The Long-Run Aggregate Supply
(LRAS) Curve5. AD, AS, and Monetary Fiscal
Policy6. Causes of Inflation (p)
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• The Aggregate Demand Curve
• aggregate demand the total demand for goods and
  services in the economy.

• Money demand f (3 variables)
• the interest rate (r),
• the level of real income (Y),
• the price level (P).
• If Y?, P ?, or the r ? ? Money demand will ?

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Deriving the Aggregate Demand Curve
The Impact of an Increase in the Price Level on
the EconomyAssuming No Changes in G, T, and Ms
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DERIVING THE AD CURVE
aggregate demand curve (AD) shows the negative
relationship between Y P. Each point on the AD
curve is a point at which both the goods market
the money market are in equilibrium.
The Aggregate Demand (AD) curve
An ? in the P causes Y the level of aggregate
output (income) to fall.
A ? in the P causes Y to rise.
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Caveat

• AD falls when the price level ? b/c the higher P
  causes the demand for money (Md) to rise.
• With the money supply (Ms) constant, the r will
  rise to reestablish equilibrium in the money
  market.
• It is the higher r that causes Y to fall.

The AD curve is not the sum of all the market
demand curves in the economy. It is not a market
demand curve.
OTHER REASONS FOR A DOWNWARD-SLOPING AD CURVE
1. The Consumption Link I does not bear all the
burden of providing the link from a higher r to a
lower level of Y. Decreased C caused by a higher
r also contributes to this effect.
2. The Real Wealth Effect The change in C
brought about by a change in real wealth that
results from a change in the P.
An increase in the price level lowers the real
value of some types of wealth.
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AGGREGATE EXPENDITURE (AE) AND AGGREGATE DEMAND
(AD)
equilibrium condition C I G Y
At every point along the AD curve, the aggregate
quantity demanded is exactly equal to planned
aggregate expenditure (AE), C I G.
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SHIFTS OF THE AD
An increase in the quantity of money supplied at
a given price level shifts the AD curve to the
right.
An increase in government purchases or a decrease
in net taxes shifts the AD curve to the right.
The Impact of an ? in the Money Supply on the AD
Curve
The Effect of an ? in G (Government Purchases) or
a ? in T (Net Taxes) on the AD Curve
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SHIFTS OF THE AD
Factors That Shift the Aggregate Demand Curve
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2. THE AGGREGATE SUPPLY CURVE
aggregate supply total supply of all goods and
services in an economy.
aggregate supply (AS) curve graph shows the
relationship between the aggregate quantity of
output supplied by all firms in an economy P
the overall price level.
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AGGREGATE SUPPLY IN THE SHORT RUN
Capacity Constraints
Output Levels and Price/Output Responses
An increase in AD when the economy is operating
at low levels of Y a little ? P will cause Y to
increase by a lot That is, the AS (price/output
response) curve is likely to be fairly flat at
low levels of aggregate output.
The Short-Run Aggregate Supply Curve
When the economy is producing at its maximum
level of outputthat is, at capacity the
aggregate supply curve becomes vertical.
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SHIFTS OF THE AS CURVE
cost shock, or supply shock A change in costs
that shifts the aggregate supply (AS) curve.
Shifts of the Aggregate Supply Curve
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Factors That Shift the Aggregate Supply Curve
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3. THE EQUILIBRIUM PRICE LEVEL
The price level at which the AD AS intersect.
The Equilibrium Price Level
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4. THE LONG-RUN AS CURVE
The long-run AS curve is vertical.
potential output (GDP) The level of aggregate
output that can be sustained in the LR without
inflation. Depends on the physical limits of
the economy.
The Long-Run Aggregate Supply Curve
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5. AD, AS, Monetary Fiscal Policy
A Shift of the AD Curve When the Economy Is on
the Nearly Flat Part of the AS Curve
A Shift of the AD Curve When the Economy Is
Operating at or Near Maximum Capacity
LONG-RUN AGGREGATE SUPPLY AND POLICY EFFECTS
If the AS curve is vertical in the LR, neither
monetary policy nor fiscal policy has any effect
on aggregate output in the LR.
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6. CAUSES OF INFLATION
INFLATION v. SUSTAINED INFLATION
Inflation An increase in the overall price level.
sustained inflation Occurs when the overall
price level continues to rise over some fairly
long period of time.
a. DEMAND PULL INFLATION
Inflation that is initiated by an increase in
aggregate demand.
b. COST-PUSH, OR SUPPLY-SIDE, INFLATION
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b. Cost-Push, or Supply-Side, Inflation
Inflation caused by an increase in costs.
Cost-Push, or Supply-Side, Inflation
Stagflation Occurs when output is falling at the
same time that prices are rising.
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EXPECTATIONS AND INFLATION
Cost Shocks Are Bad News for Policy Makers
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MONEY AND INFLATION
hyperinflation A period of very rapid increases
in the price level
Sustained Inflation from an Initial Increase in G
and Fed Accommodation