Download aggregate supply curve

9
Aggregate Demand & Aggregate Supply
STICKY PRICES AND THEIR
MACROECONOMIC CONSEQUENCES
• short run in macroeconomics
The period of time in which prices do not change or do not
change very much. We call these prices “sticky”.
• sticky prices
If wages are sticky, firms’ overall costs will be sticky as well. Sticky
wages cause sticky prices and hamper the economy’s ability to bring
demand and supply into balance in the short run.
• causes of sticky prices
In the macroeconomic short run, both formal and informal contracts
between firms mean that changes in demand will be reflected
primarily in changes in output, not prices.
UNDERSTANDING AGGREGATE DEMAND

What Is the Aggregate Demand Curve?
• aggregate demand curve (AD)
A curve that shows the
relationship between the level of
prices and the quantity of real
GDP demanded.
UNDERSTANDING AGGREGATE DEMAND
As the purchasing power of money changes, the aggregate demand curve is affected
in three different ways:
WEALTH
• wealth effect
The increase in spending that occurs because the real
value of money increases when the price level falls.
INTEREST RATES
• interest rate effect
With a given money supply in the economy, a lower
price level will lead to lower interest rates and higher
consumption and investment spending.
INTERNATIONAL TRADE
• international trade effect
A lower price level makes domestic goods cheaper
relative to foreign goods.
UNDERSTANDING AGGREGATE DEMAND

Shifts in the Aggregate Demand Curve
Key factors that cause the shifts:
CHANGES IN THE SUPPLY OF MONEY
CHANGES IN TAXES
CHANGES IN GOVERNMENT SPENDING
ALL OTHER CHANGES IN DEMAND
HOW THE MULTIPLIER MAKES THE SHIFT
BIGGER
The relationship between the level of income and
consumption spending is called the
consumption function:
C = Ca + by
Ca = autonomous consumption, or the amount
of consumption spending that does not depend
on the level of income.
by = the part of consumption that is dependent
on income, where:
b = marginal propensity to consume (MPC), or The
fraction of additional income that is spent.
y = level of income in the economy.
UNDERSTANDING AGGREGATE DEMAND

How the Multiplier Makes the Shift Bigger
• marginal propensity to save (MPS)
The fraction of additional income that is saved.
• Spending Multiplier
The ratio of the total shift in aggregate demand to the initial shift
in aggregate demand.
UNDERSTANDING AGGREGATE DEMAND

How the Multiplier Makes the Shift Bigger
The Multiplier
UNDERSTANDING AGGREGATE SUPPLY
• aggregate supply curve (AS)
A curve that shows the relationship between the level of prices and
the quantity of output supplied.

The Long-Run Aggregate Supply Curve
• long-run aggregate supply curve (LRAS)
A vertical aggregate supply curve that represents the idea that in the
long run, output is determined solely by the factors of production.
Long-Run Aggregate Supply
UNDERSTANDING AGGREGATE SUPPLY

The Long-Run Aggregate Supply Curve
DETERMINING OUTPUT AND THE PRICE LEVEL
Aggregate Demand and the LongRun Aggregate Supply
UNDERSTANDING AGGREGATE SUPPLY

The Short-Run Aggregate Supply Curve
• short-run aggregate supply curve (SRAS)
A relatively flat aggregate supply curve that
represents the idea that prices do not change very
much in the short run and that firms adjust
production to meet demand.
Aggregate Demand and
Short-Run Aggregate Supply
UNDERSTANDING AGGREGATE SUPPLY

Supply Shocks
• supply shocks
External events that shift the aggregate supply curve.
Supply Shock
• stagflation
A decrease in real output with increasing prices.
FROM THE SHORT RUN TO THE LONG RUN
The Economy in the Short Run
FROM THE SHORT RUN TO THE LONG RUN
Adjusting to the Long Run