Download Aggregate Demand and Aggregate Supply

Ch. 7: Aggregate
Demand and Aggregate
Supply
James R. Russell, Ph.D., Professor of Economics & Management, Oral Roberts University
©2005 Thomson Business & Professional Publishing, A Division of Thomson Learning
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Aggregate Demand


Aggregate Demand: the quantity
demanded of all goods and services
(Real GDP) at various price levels,
ceteris paribus.
Aggregate Demand (AD) Curve: a
curve that shows the quantity
demanded of all goods and services
(Real GDP) at various price levels,
ceteris paribus.
2
Exhibit 1: The Aggregate
Demand Curve
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Aggregate Demand


Monetary Wealth: the value of a
person’s monetary assets.
Purchasing Power: the quantity of
goods and services that can be
purchased with a unit of money.
Purchasing power and the price level
are inversely related.
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Why Does the Aggregate Demand
Curve Slope Downward?



Real Balance Effect: the change in the
purchasing power of dollar-denominated
assets that result from a change in the price
level.
Interest Rate Effect: the changes in
household and business buying as the
interest rate changes.
International Trade Effect: the change in
foreign sector spending as the price level
changes.
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Exhibit 2: Why the Aggregate Demand
Curve is Downward-Sloping?
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Exhibit 2: Why the Aggregate Demand
Curve is Downward-Sloping?
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Exhibit 2: Why the Aggregate Demand
Curve is Downward-Sloping?
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Exhibit 3: A Change in the Quantity
Demanded of Real GDP versus a
Change in Aggregate Demand
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How Spending Components
Affect Aggregate Demand


Components of
Spending:
– Consumption
– Investment
– Government
Purchases
– Net Exports
A change in any of
these components will
affect aggregate
demand.
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Changes in Aggregate
Demand


If at a given price level, Consumption,
Investment, Government Purchases, or
Net Exports increase, then Aggregate
Demand will increase.
If at a given price level, Consumption,
Investment , Government Purchases, or
Net Exports decrease, the Aggregate
Demand will decrease.
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Exhibit 4: Changes in
Aggregate Demand
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What Causes Consumption
to Change?




Wealth
Expectations about
future prices and
Income
Interest rate
Income taxes
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What Causes Investment
to Change?
 The
interest rate
 Expectations about future
sales
 Business taxes
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What Would Change Net
Exports?
Foreign real
national
income
 Exchange rate

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Exhibit 5: Factors That Change
Aggregate Demand
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The Interest Rate and the
Loanable Funds Market


Interest rates can
change consumption
and investment.
Interest rates are
market determined in
the loanable funds
market.
17
Exhibit 6: The Loanable Funds Market
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The Loanable Funds Market


Demand shifters are anything that will cause
one or more of the four sectors (C,I,G,NX)
to borrow more will shift demand.
Supply shifters are anything that prompts
one or more of the four sectors (C,I,G,NX)
to loan more funds.
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Can a Change in the Money Supply
Change Aggregate Demand?
Yes. We’ll
discuss in
detail in later
chapters.
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Self-Test




Explain the real balance effect.
Explain what happens to the AD curve if the
dollar appreciates relative to other
currencies.
Explain what happens to the AD curve if
personal income taxes decline.
What happens to the demand for loanable
funds and the interest rate if the budget
deficit becomes smaller (but not zero)?
Explain.
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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.
 The Short-Run Aggregate Supply
Curve (SRAS) is upward sloping.

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Exhibit 7: The Short-Run
Aggregate Supply Curve
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Short-Run Aggregate Supply Curve:
What it is and Why is it UpwardSloping?


Short-Run Aggregate Supply Curve
(SRAS): a curve that shows the quantity
supplied of all goods and services (Real GDP)
at different price levels, ceteris paribus.
Why is it upward-sloping?
– Sticky Wages
– Sticky Prices
– Menu Costs
– Producer Misperceptions
– Worker Misperceptions
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The Difference Between ShortRun And Long-Run Aggregate
Supply Curve
The Following Will Change Over
Time:
 Sticky Wages
 Sticky Prices
 Producer Misperceptions
 Worker Misperceptions
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Shifts in the Aggregate
Supply Curve
Wage Rates
 Prices of Nonlabor Inputs
 Productivity
 Supply Shocks

26
Exhibit 8: Wage Rates and a Shift in the
Short-Run Aggregate Supply Curve
(same applies to changes in prices
of other non-labor inputs)
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Shifts in the Short-Run
Aggregate Supply Curve


Productivity:
describes the output
produced per unit of
input employed over
some time.
An increase in
productivity causes
the SRAS to shift
rightward. A decrease
in productivity causes
the SRAS to shift to the
left.
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Shifts in the Aggregate
Supply Curve


Supply Shocks:
major natural or
institutional changes
on the supply side of
the economy that
affect aggregate
supply.
A supply shock might
include a drought in
the Midwest, or finding
more oil in the middle
east.
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Exhibit 9: Changes in Short-Run
Aggregate Supply
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Self-Test



If wage rates decline, explain what
happens to the short-run aggregate
supply (SRAS) curve?
Give an example of an increase in
labor productivity.
What are menu costs and what role do
they play in the sticky-price
explanation for an upward-sloping
SRAS curve?
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How Short-Run Equilibrium
In The Economy Is Achieved



AD and SRAS determine the price level, real
GDP, and the unemployment rate in the
short run.
In instances of both surplus and shortage,
economic forces are moving the economy
toward the short-run equilibrium point.
Ceteris paribus, we expect a higher real
GDP level to be associated with a lower
unemployment rate and a lower real GDP
level to be associated with a higher
unemployment rate.
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Exhibit 10: Short-Run Equilibrium
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Exhibit 11: Changes in Short-Run
Equilibrium in the Economy
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Ceteris Paribus Makes All The Difference
in the Relationship between Real GDP and
the Unemployment Rate


If other things change,
it may appear as if the
inverse relationship
between the
unemployment rate
and Real GDP doesn’t
hold.
Economics is about
establishing a
connection or link
between an effect and
a correct cause.
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Exhibit 12: How a Factor Affects the
Price Level, Real GDP, and the
Unemployment Rate in the Short Run
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Exhibit 13: A Summary Exhibit of AD
and SRAS
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Q & A: Identify what will happen to
the price level and Real GDP when
each of the following occurs:




Short-Run
Aggregate
rises
Short-Run
Aggregate
falls
Aggregate
rises
Aggregate
falls

Supply
Supply

Demand
Demand
Aggregate Demand
rises by more than
the Short-Run
Aggregate Supply
rises
Aggregate Demand
falls by less than
the Short-Run
Aggregate Supply
falls
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Long Run Aggregate
Supply


Short-Run equilibrium identifies the Real
GDP the economy produces when any of
these conditions hold: sticky wages,
sticky prices, producers’ misperceptions,
workers’ misperceptions.
Wages and prices eventually become
unstuck and misperceptions will turn to
accurate perceptions: when this happens
the economy is said to be in The Long
Run.
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Exhibit 14: Long-Run Aggregate
Supply (LRAS) Curve
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Exhibit 15: Equilibrium States of the
Economy
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Questions Economists Ask

What can cause the
economy to move
from one short-run
equilibrium position
to another shortrun equilibrium
position?
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Questions Economists Ask



What happens to certain economic variables
such as the price level and Real GDP, as the
economy moves from one short-run equilibrium
to another short-run equilibrium?
If the economy is in the short-run equilibrium,
what path does it travel to long-run
equilibrium?
How long does it take the economy to move
from short-run equilibrium to long-run
equilibrium?
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Questions Economists Ask


If the economy is in
long-run equilibrium,
what must happen to
move it to another
long-run equilibrium?
How long does it take
to move from one
long-run equilibrium
position to another
long-run equilibrium
position?
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Questions Economists Ask


Are some of the states
of an economy better
than other states?
If some states of the
economy are better
than others, is there
anything that
government can do to
move the economy
from one state to
another?
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Exhibit 16: Different States of the
Economy
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Coming Up (Ch. 8): The
Self-Regulating Economy
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