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Aggregate Supply, Aggregate
Demand and Unemployment
Week 4
Professor Dermot McAleese
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
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)
L*
Quantity of labour
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
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
CAUSES OF UNEMPLOYMENT – A
PRELIMINARY VIEW
Minimum Wage
Trade union power
Tax wedge
Hysteresis
See CHAPTER 14 – and CHAPTER 10 for
further details
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
SHIFTS IN THE AD CURVE
– an upsurge in business expectations leads to higher investment
– consumers decide to increase their spending
– people’s preferences for holding money change
– the monetary authorities increase the money supply
AD = AS at E
AD = national spending = national income = national output = AS
Price (P)
AS
P2
E
P0
P1
0
AD
Y2
Y0
Y1
Output (Y)