Aggregate Demand And Aggregate Supply

1
Aggregate Demand And Aggregate Supply
2
The Aggregate Demand Curve (AD)

• The aggregate demand curve is downward sloping,
  specifying an inverse relationship between the
  price level and the quantity demanded of Real
  GDP, ceteris paribus.

3
The Aggregate Demand Curve (continued)

• Real GDP
• the value of the entire output produced
  annually within a countrys borders, adjusted for
  price changes.

4
The Aggregate Demand Curve (continued)
Year Price of good X Quantity produced of good X (units) GDP Real GDP
1 (base year) 10 100 10 x 100 1000 10 x 100 1000
2 12 120 12 x 120 1440 10 x 120 1200
3 14 140 14 x 140 1960 10 x 140 1400
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The Aggregate Demand Curve (continued)
Aggregate Demand
Price Index Quantity demanded of goods and services (quantity demanded of real GDP)
100 1200
110 1000
120 800
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Why Does The Aggregate Demand Curve Slope
Downward?

• Explained by the real balance effect, the
  interest rate effect, and the international trade
  effect.

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Real Balance Effect (Due To A Change In The Price
Level)Monetary Wealth (Money Holdings)

• Example
• A person who has 50000 in cash.
• Suppose the price level falls.
• Causes the purchasing power of the persons
• 50000 rises.
• Becomes wealthier, buys more goods.
• Exhibit 2 Real Balance In Effect Page 155.

8
Interest Rate Effect (Due To A Change In The
Price Level)

• Consider of a person who buy a fixed bundle of
• goods each week. Suppose the price level falls,
• increasing the purchasing power of the persons
• money. With more purchasing power, the
• person can purchase fixed bundle with less
• money. The person will save money more,
• causes the supply of credit increases, which is
• the interest rate drops. Households and
  businesses
• borrow more, buying more goods, Real GDP rises.
• Exhibit 2 Page 155 Interest Rate Effect

9
International Trade Effect

• The change in foreign sector spending as the
  price level changes.
• Exhibit 2 Page 155 International Trade
  Effect.

10
A Change In The Quantity Demanded Of Real GDP
Versus A Change In Aggregate Demand

• A change in the quantity demanded of real GDP is
  brought about by a change in the price level.
• Exhibit 3 Page 156 figure a.

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A Change In The Quantity Demanded Of Real GDP
Versus A Change In Aggregate Demand (continued)

• A change in aggregate demand is represented as a
  shift in the aggregate demand curve.
• Exhibit 3 Page 156 figure b.

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Changes In Aggregate Demand Shifts In The AD
Curve

• Aggregate demand changes when the spending on
  goods and services changes.
• If spending increases at a given price level,
  aggregate demand increases.
• If spending decreases at a given price level,
  aggregate demand decreases.

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How Spending Components Affect Aggregate Demand?

• Let
• C 100
• I 100
• G 100
• EX 50
• IM 15
• 335 is spent on goods and services
• Total expenditure on goods and services C I
  G NX
• C increases, I increases, G increases, NX
  increases Total expenditure increases
• C decreases, I decreases, G decreases, NX
  decreases Total expenditure decreases

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Factors That Can Change C, I, G, NX And Therefore
Can Change AD

• Consumption,
• 4 factors that can affect consumption, such
  as
• 1. Wealth
• wealth increases..consumption
• increases.AD increases
• wealth decreases..consumption
• decreases.AD decreases

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Factors That Can Change C, I, G, NX And Therefore
Can Change AD (continued)

• Consumption,
• 4 factors that can affect consumption, such
  as
• 2. Expectations about future prices and
  income
• Expect higher future prices.consumption
  
• increases..AD increases
• Expect lower future prices.consumption
• decreases..AD decreases
• Expect higher future income.consumption
  
• increases..AD increases
• Expect lower future income.consumption
  decreases.AD
• decreases

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Factors That Can Change C, I, G, NX And Therefore
Can Change AD (continued)

• Consumption,
• 4 factors that can affect consumption, such
  as
• 3. Interest rate
• Interest rate increases..consumption
• decreases.AD decreases
• Interest rate decreases.consumption
• increases.AD increases

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Factors That Can Change C, I, G, NX And Therefore
Can Change AD (continued)

• Consumption,
• 4 factors that can affect consumption, such
  as
• 4. Income taxes
• Income taxes increases..consumption
• decreases.AD decreases
• Income taxes decreasesconsumption
• increases..AD increases

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Factors That Can Change C, I, G, NX And Therefore
Can Change AD (continued)

• Investment
• 3 factors that can affect investment, such
  as
• 1. Interest rate
• Interest rate increases..investment
• decreases.AD decreases
• Interest rate decreasesinvestment
• increases..AD increases

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Factors That Can Change C, I, G, NX And Therefore
Can Change AD (continued)

• Investment
• 3 factors that can affect investment, such
  as
• 2. Expectations about future sales
• Businesses become optimistic about
• future sales.Investment
• increases..AD increases
• Businesses become pessimistic about
• future sales.Investment
• decreases..AD decreases

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Factors That Can Change C, I, G, NX And Therefore
Can Change AD (continued)

• Investment
• 3 factors that can affect investment, such
  as
• 3. Business taxes
• Business taxes increases.Investment
• decreases..AD decreases
• Business taxes decreases.Investment
• increases.AD increases

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Factors That Can Change C, I, G, NX And Therefore
Can Change AD (continued)

• Net export
• 2 factors that can affect investment, such
  as
• 1. Foreign real national income
• Foreign real national income
• increasesExports increases.Net export
  
• increases..AD increases
• Foreign real national income
• decreasesExports decreases.Net export
  
• decreases..AD decreases

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Factors That Can Change C, I, G, NX And Therefore
Can Change AD (continued)

• Net export
• 2 factors that can affect investment, such
  as
• 2. Exchange rate
• Dollar depreciates.US exports
• increases and US imports decreases.US
  net
• exports increases.AD increases
• Dollar appreciates.US exports
• decreases and US imports increases.US
  net
• exports decreases.AD decreases

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Short Run Aggregate Supply

• Aggregate supply
• the quantity supplied of all goods and
  services (Real GDP) at different price levels,
  ceteris paribus.
• Exhibit 6 Page 162

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Changes In Short Run Aggregate Supply Shifts In
The SRAS Curve

• A change in quantity supplied of real GDP is
  brought about by a change in the price level.
• The factors that can shift the SRAS curve
  include
• - wage rates,
• - prices of non labor inputs,
• - productivity,
• - supply shock.

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Wage Rate

• Exhibit 7 Page 164

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Prices Of Non Labor Inputs

• Almost the same as
• Exhibit 7 Page 164
• Increase the price non labor input.shift the
  SRAS curve leftward.
• Decrease the price non labor input.shift the
  SRAS curve rightward.

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Productivity

• Increase in productivity.SRAS curve to shift
  right.
• Decrease in productivity.SRAS curve to shift
  left.

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Putting AD and SRAS Together Short Run
Equilibrium

• Exhibit 9 Page 167

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Thinking In Terms Of Short Run Equilibrium
Changes In The Economy

• Exhibit 10 Page 167
• Figure a. An increase AD
• Figure b. An increase SRAS
• Figure c. A decrease SRAS

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Long Run Aggregate Supply (LRAS)

• LRAS curve
• The LRAS curve is a vertical line at the
  level of Natural Real GDP.
• It represents the output the economy produces
  when wages and prices have adjusted to their
  (final) equilibrium levels and neither producers
  nor workers have any relevant misperceptions.
• Exhibit 13. Page 172

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• Natural real GDP
• the real GDP that it produced at the natural
  unemployment rate. The real GDP that is produced
  when the economy is in long run equilibrium.

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Short Run Equilibrium, Long Run Equilibrium, And
Disequilibrium

• Exhibit 14 Page 172

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Case 1

• Diagrammatically represent the effect on the
  price level and real GDP in the short run of each
  following
• a. A decrease in wealth.
• b. An increase in wage rate.
• c. A decrease in labor productivity.

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Case 2

• Diagrammatically represent the following and
  identify the effect on real GDP and the price
  level in the short run
• a. An increase in SRAS that is greater than
• the increase in AD.
• b. A decrease in AD that is greater than the
  
• increase in SRAS.
• c. An increase in SRAS that is less than the
  
• increase in AD

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Case 3

• In the following figure, which part is
  representative of each of the following
• a. A decrease in wage rates.
• b. An increase in the price level.
• c. A beneficial supply shock.
• d. An increase in the price of non labor
• inputs.

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Case 4

• In the following figure, which of the points is
  representative of each of the following
• a. The lowest real GDP.
• b. The highest real GDP.
• c. A decrease in SRAS that is greater than an
  
• increase in AD.