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Chapter 29: Aggregate Demand and Aggregate Supply
1. Aggregate Demand is a schedule or curve showing the various amounts of goods/services (i.e. real
output) that domestic consumers, businesses, government, and foreign buyers collectively desire to
purchase at each possible price level. There are three reasons for the downward slope of AD where a
higher price level will decrease the quantity of real GDP demanded and a lower price level will increase
the quantity of real GDP demanded.
a) real-balances effect: a higher price level reduces the real value or purchasing power of the
public’s accumulated financial assets
b) interest – rate effect: a higher price level increases the demand for money and (assuming a fixed
supply of money) raises the interest rate which reduces consumption and investment
c) foreign purchasing effect: a higher price level makes U.S. exports relatively expensive and
foreign imports relatively cheap reducing net exports (X – M) a component of aggregate demand
2. Determinants of aggregate demand will increase (shift right) or decrease (shift left) AD at all price
levels. Factors that will increase AD include:
consumption spending (increase in consumer wealth, expectations of future price increases, household debt
and taxes – see explanation above)
b) investment spending (decrease in rate, higher expected returns on investment, lower business
taxes, new technology, excess capacity)
c) government spending
d) net export spending (rising foreign national income, depreciation of U.S. dollar)
3. Aggregate supply is a schedule or a curve showing the level of real domestic output, which will be
produced, at each price level. There are three regions of the AS curve: a) horizontal or Keynesian b)
upward sloping and c) vertical or classical.
4. Determinants of aggregate supply will increase (shift right) AS at all
price levels. When per-unit costs decrease, aggregate supply will increase
and when per-unit costs increase, AS will decrease. Some aggregate
supply determinants include:
a) lower input prices (for labor, land and capital) will increase AS
b) an appreciation of the dollar will lower the price of imported
resources and increase AS
c) increased productivity = total output/total inputs will lower costs
and increase AS
d) supply-side economic policies that lower business taxes will reduce costs and increase AS
5. The equilibrium price level and equilibrium real GDP occur where AD = AS.
6. The effect of changes in AD on equilibrium price level and output depend upon which of the three ranges
the shift in AD occurs. If AD increased, the following table summarizes the effects:
Price Level:
Real GDP:
Multiplied Effect:
no change
large increase
full effect
moderate increase
moderate increase
reduced effect
large increase
no increase