AD & AS aggreate demand and aggreate supply

8/22/2019 AD & AS aggreate demand and aggreate supply

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Aggregate Demand/AggregateSupply

The basic model of

short-run economic

fluctuations


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Aggregate Demand and Supply


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The basic model of economic

fluctuations

The basic model of aggregate demand

and aggregate supply Economists use the model of aggregate

demand and aggregate supplyto explain

short-run fluctuations in economic activity

around its long run trend.


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fluctuations

The Basic Model of Aggregate Demand

and Aggregate Supply The aggregate-demand curveshows the

quantity of goods and services that

households, firms, and the government want

to buy at each price level.


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fluctuations

The Basic Model of Aggregate Demand

and Aggregate Supply The aggregate-supply curveshows the

quantity of goods and services that firms

choose to produce and sell at each price

level.


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Aggregate Demand and Aggregate Supply...

Quantity ofOutput

PriceLevel

0

Aggregatesupply

Aggregatedemand

Equilibriumoutput

Equilibriumprice level


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Aggregate Demand (AD)


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THE AGGREGATE-DEMAND

CURVE

The four components of GDP (Y)

contribute to the aggregate demand forgoods and services.

Y = C + I + G + NX


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The Aggregate-Demand Curve...

Quantity ofOutput

PriceLevel

0

Aggregatedemand

P

Y Y2

P21. A decreasein the pricelevel . . .

2. . . . increases the quantity ofgoods and services demanded.


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Why the Aggregate-Demand Curve IsDownward Sloping The Price Level and Consumption: The

Wealth Effect The Price Level and Investment: The

Interest Rate Effect

The Price Level and Net Exports: TheExchange-Rate Effect


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Why the Aggregate-Demand Curve IsDownward Sloping The Price Level and Consumption: The

Wealth Effect

A decrease in the price level makes

consumers feel more wealthy, which in turn

encourages them to spend more.

This increase in consumer spending means

larger quantities of goods and services

demanded.


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Why the Aggregate-Demand Curve IsDownward Sloping The Price Level and Investment: The

Interest Rate Effect

A lower price level reduces the interest rate,

which encourages greater spending on

investment goods.

This increase in investment spending means

a larger quantity of goods and services

demanded.


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Why the Aggregate-Demand Curve IsDownward Sloping The Price Level and Net Exports: The

Exchange-Rate Effect

When a fall in the U.S. price level causes

U.S. interest rates to fall, the real exchange

rate depreciates, which stimulates U.S. net

exports. The increase in net export spending means

a larger quantity of goods and services

demanded.


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Why the Aggregate-Demand CurveMight Shift The downward slope of the aggregate demand

curve shows that a fall in the price level raises

the overall quantity of goods and servicesdemanded.

Many other factors, however, affect the quantity

of goods and services demanded at any givenprice level.

When one of these other factors changes, the

aggregate demand curve shifts.


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Why the Aggregate-Demand CurveMight Shift Shifts arising from

Consumption Investment

Government Purchases

Net Exports


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Consumption Expenditure

Exogenous factors affecting consumption: Tax rates

Incomes short term and expected income over lifetime

Wage increases

Credit Interest rates

Wealth

Property

Shares

Savings


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Investment Expenditure Spending on:

Machinery

Equipment

Buildings

Infrastructure

Influenced by:

Expected rates of return

Interest rates

Expectations of future sales

Expectations of future inflation rates


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Government Spending

Defence Health

Social Welfare

Education

Foreign Aid

Regions

Industry

Law and Order


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Import Spending (negative)

Goods and services bought from abroad

represents an outflow of funds from

the country (reduces AD)


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Export Earnings (Positive)

Goods and services sold abroad

represents a flow of funds into the

country (raises AD)


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Key Variables


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Macroeconomic Policy


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Shifts in the Aggregate

Demand Curve

Quantity of

Output

PriceLevel

0

Aggregatedemand, D1

P1

Y1

D2

Y2


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Aggregate Supply (AS)


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The Aggregate Supply Curve

Aggregate supply is the total supply of all

goods and services in the economy.

The agg regate supp ly(AS) curveis a

graph that shows the relationship

between the aggregate quantity of outputsupplied by all firms in an economy and

the overall price level.


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Keynesian & Classical AggregateSupply Functions


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THE AGGREGATE-SUPPLY

CURVE

In the long run, the aggregate-supply

curve is vertical.

In the short run, the aggregate-supply

curve is upward sloping.


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THE AGGREGATE-SUPPLY

CURVE

The Long-Run Aggregate-Supply Curve In the long run, an economys production of

goods and services depends on its supplies

of labor, capital, and natural resources and

on the available technology used to turn

these factors of production into goods andservices.

The price level does not affect these

variables in the long run.

Th L R A t S l C


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The Long-Run Aggregate-Supply Curve

Quantity ofOutput

PriceLevel

0

Long-runaggregate

supply

P21. A changein the pricelevel . . .

2. . . . does not affect

the quantity of goodsand services supplied

in the long run.

P


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Shifts in the LR-Aggregate Supply

Any change in the economy that alters thenatural rate of output shifts the long-run

aggregate-supply curve. The shifts may be categorized according to

long-run changes in

Labor

Capital Natural resources

Technological knowledge


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Why the Aggregate-Supply CurveSlopes Upward in the Short Run In the short run, an increase in the overall

level of prices in the economy tends to

raise the quantity of goods and services

supplied.

A decrease in the level of prices tends toreduce the quantity of goods and

services supplied.

Th Sh t R A t S l C


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The Short-Run Aggregate-Supply Curve

Quantity ofOutput

Price

Level

0

Short-runaggregate

supply

1. A decreasein the pricelevel . . .

2. . . . reduces the quantityof goods and servicessupplied in the short run.

Y

P

Y2

P2


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Why the Aggregate-Supply CurveSlopes Upward in the Short Run Macroeconomists focus on whether or

not the economy as a whole is operating

at full capacity.

Even if firms are not holding excess labor

and capital, the economy may beoperating below its capacity if there is

cyclical unemployment.


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Shifts of the Short-RunAggregate Supply Curve

A leftward shift of the

AS curve could be

caused by cost

shocks.

A decrease in costs,

economic growth, or public

policy, can cause a rightward

shift of theAS curve.


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deregulation

Bad weather, natural

disasters, destruction

from wars

Good weather

Public policyPublic policy waste and inefficiency supply-side policies over-regulation tax cuts

Capital deterioration more capital more labor

higher input prices lower input prices higher wage rates lower wage rates

Factors That Shift the Aggregate Supply Curve

Shifts to the LeftDecreases in Aggregate Supply

Shifts to the RightIncreases in Aggregate Supply

technological change

StagnationEconomic growth

Higher costsLower costs


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The Equilibrium

The equ i l ibr ium price level and

agg regate ou tpu tis the point at which

the aggregate demand and aggregate

supply curves intersect.


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TWO CAUSES OF

ECONOMIC FLUCTUATIONS

Shifts in Aggregate Demand In the short run, shifts in aggregate demandcause fluctuations in the economys output of

goods and services.

In the long run, shifts in aggregate demand

affect the overall price level but do not affectoutput.

I i AD D d P ll


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Increase in AD Demand-PullInflation

An increase in

aggregate demand

when the economy is

operating at low levels

of output is likely to

result in an increase in

output with little or no

increase in the overall

price level.

As the economy approaches maximum capacity, firms

respond to further increases in demand only by

raising prices.

D i AD R i d


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Decreases in AD: Recession andUnemployment

Price

Real National Income

AS

Yf

AD1

P1

Y1

AD0

Y0

P0

In the short-run,

decreases in AD will

reduce equilibrium

GDP and cause

unemployment

LR D i AD i t


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LR Decrease in AD: no impact onoutput

Price


AS

Yf

AD1

P1 AD0

P0


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Short Run Adverse Shift in AS

Price


AS0

AD1

P1

Y1

AD0

Y

0

P0

In the short-run,

decreases in AS will

reduce equilibrium

GDP and cause

prices to rise.

AS1


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The Effects of a Shift in AggregateSupply

StagflationAdverse shifts in aggregate supply causestagflationa period of recession and

inflation.

Output falls and prices rise.

Policymakers who can influence aggregatedemand cannot offset both of these adverseeffects simultaneously.


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Long Run Adverse Shift in AS

Price


AS0

AD1

P1

Y1

AD0

Y

0

P0

In the long-run,

decreases in AS will

also reduce

equilibrium GDP and

cause prices to rise.

AS1


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END..

AD & AS aggreate demand and aggreate supply

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