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Chapter 19
Aggregate Demand and
Aggregate Supply
Principles of Economics
by Fred M Gottheil
PowerPoint Slides prepared by Ken Long
5/23/2017
©1999 South-Western College Publishing
1
What is the
Business Cycle?
Alternating periods of
growth and decline in an
economy’s GDP
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Aggregate Output
Trough
Peak
The Business Cycle
Time
3
3
What are the four stages
of the Business Cycle?
• trough
• expansion
• peak
• recession
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Aggregate Output
Trough
Peak
The Business Cycle
Time
5
5
Aggregate Output
The Business Cycle
Peak
Recession
Expansion
Trough
Time
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What is a Recession?
A phase in the business cycle
in which the decline in the
economy’s real GDP persists
for at least 6 months
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What is a Depression?
A severe recession
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What is Prosperity?
A phase in the business cycle
marked by a relatively high
level of real GDP, full
employment, and inflation
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What is Inflation?
An increase in the price level
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How do we measure
Economic Growth?
Gross Domestic Product
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What is
Gross Domestic Product?
GDP is the total value of all
final goods and services
measured in current market
prices, produced in the
economy in any one year
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What is a Final Good?
A good that is not itself used
to produce other goods
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What does “measured
in current market
prices” mean?
The year in which the
good was made, the
current market price
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What does “produced in
the economy” mean?
It is produced domestically
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For the latest measure
of GDP visit http://www.whitehouse.gov/
fsbr/esbr.html
http://www.bea.doc.gov
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How do we make
adjustments for prices?
We measure both
Nominal and Real GDP
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What is Nominal GDP?
GDP measured in terms of
current market prices - it is
not adjusted for inflation
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What is Real GDP?
GDP adjusted for changes
in the price level
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What is a Base Year?
The reference year with
which prices in other
years are compared in a
price index
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What is the Price Level?
A measure of prices in one
year expressed in relation
to prices in a base year
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What is the Consumer
Price Index?
A measure comparing the
prices of consumer goods
and services that a household
typically purchases
compared to a base year
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What is the value of the
index in the base year?
100
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If nominal GDP is $750
billion and the price
index for that year is
1.11, then real GDP =
$750/1.11 (or) $675.68
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What is the Consumer
Price Index (CPI)?
A measure over time of the
cost of a fixed ‘market
basket’ of consumer goods
and services
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How does the GDP
index compare with the
CPI index?
GDP uses a different basket
of goods and services each
year whereas the CPI uses
a fixed basket determined
in the base year
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For the latest measure
of CPI visit http://stats.bls.gov/cpihome.htm
http://woodrow.mpls.frb.fed.us/eco
nomy/calc/hist1913.html
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What is the
GDP Price Deflator?
A measure comparing the prices
of all goods and services
produced in the economy during
a given year to the prices of
those goods and services
purchased in a base year
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For current and historical
data on production http://www.bog.frb.fed.us/releases
http://www.census.gov
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What is
Aggregate Demand?
The total quantity of goods
and services demanded by
households, firms,
foreigners, and government
at varying price levels
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Price
Level
AD
Real GDP
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What factors can explain
the downward slope of
Aggregate Demand?
• Real wealth effect
• Interest rate effect
• International trade effect
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Real Wealth Effect
As the price level rises,
real purchasing power of
some assets declines,
thus may reduce
spending
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Interest Rate Effect
A rise in the price level
can raise interest rates,
leading to less
consumption and
investment spending
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International Trade
Effect
A rise in domestic prices
relative to foreign prices
will reduce exports, raise
imports
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What factors can cause a
shift in Aggregate
Demand? A change in ...
• government spending
• taxes
• income abroad
• expectations
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What is
Aggregate Supply?
The total quantity of goods
and services that firms
are willing to supply at
varying price levels
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What is the Shape of the
AS curve?
Very controversial,
different ways of viewing
AS curve
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One type of AS curve, 3
sections to it
Horizontal section
Upward sloping section
Vertical section
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Aggregate Supply Curve
Price
level
AS
Real GDP
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Why is Aggregate
Supply perfectly vertical
at higher levels of GDP?
Because all resources are
fully employed beyond
some level of GDP
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Why is the Aggregate
Supply Curve horizontal
at low levels of GDP?
Because so many
resources are not used
or are under utilized
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Why is the AS Curve
upward sloping at higher
levels of GDP?
Because we have run out of
some resources so an
increase in demand causes
those prices to increase
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Aggregate Supply Curve
Price
level
AS
Real GDP
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What is
Macroequilibrium?
The level of real GDP and
the price level that equate
the aggregate quantity
demanded and the
aggregate quantity supplied
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Shifts in the AD Curve
Price
level
AS
P2
AD2
P1
AD1
Q1
Q2
Real
GDP
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Will any increase in
demand cause inflation?
No! It depends on where
the aggregate demand
curve falls on the
aggregate supply curve
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Aggregate Supply Curve
AS
Price
level
AD4
AD3
AD2
AD1
Real GDP
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Shifts in the AS Curve
Price
level
AS2
AS1
P2
P1
AD1
Q2
Q1
Real
GDP
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What factors can cause a
shift in Aggregate
Supply? A change in ...
• resource availability
• wages
• interest rates
• rents
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What is an example of
AD moving along a
horizontal AS Curve?
Roosevelt’s New Deal
programs in the 1930’s
and war related
spending after 1939
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What is an example of
AD moving along a
positive AS Curve?
Spending on the Viet Nam
War in the 1960’s
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What is
Demand Pull Inflation?
Inflation caused primarily
by an increase in
aggregate demand
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What is an example of
a decrease in Aggregate
Supply?
The OPEC legacy
of the 1970’s
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What is
Cost-Push Inflation?
Inflation cause primarily
by a decrease in
aggregate supply
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What other problem can
Cost-Push Inflation cause?
Unemployment
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What is Stagflation?
A period of stagnating
real GDP, inflation, and
relatively high levels of
unemployment
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For current wealth and
income data http://www.whitehouse.gov/fsbr/i
ncome.html
http://www.bea.doc.gov
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• What is a Recession?
• What is a Depression?
• What are the four stages of the
Business Cycle?
• What is Gross Domestic Product?
• What is Nominal GDP?
• What is Real GDP?
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•What is the Consumer Price Index?
•What is the GDP Price Deflator?
•What is Aggregate Demand?
•What is Aggregate Supply?
•What is Macroequilibrium?
•What is Stagflation?
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