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30 Aggregate Demand and Aggregate Supply McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved. Aggregate Demand • Real GDP demanded at each price • LO1 level Inverse relationship (as price level goes up, real output demanded goes down). • Real-Balances effect • Interest-Rate effect • Foreign purchases effect 29-2 Price level Aggregate Demand AD 0 LO1 Real domestic output, GDP 29-3 Changes in Aggregate Demand • Determinants of aggregate demand • LO1 (aggregate demand shifters) • Factors that affect C, I, G, Xn 2 components involved • Change in one of the determinants • Multiplier effect 29-4 Price level Changes in Aggregate Demand AD2 AD3 AD1 0 Real domestic output, GDP LO1 29-5 Aggregate Supply • Total real output produced at each price • LO2 level Relationship depends on time horizon • Short run – output will respond to changes in the price level. • Long run – vertical (or constant) at full employment. In the long-run, we will produce what the economy is capable of producing, no more, no less. 29-10 Aggregate Supply: Short Run AS Price level Aggregate supply (short run) 0 Qf Real domestic output, GDP LO2 29-12 Aggregate Supply: Long Run Price level ASLR Long-run aggregate supply 0 Qf Real domestic output, GDP LO2 29-13 Changes in Aggregate Supply • Determinants of aggregate supply • • LO2 (aggregate supply shifters). Collectively position the AS curve Changes raise or lower per-unit production costs 29-14 Changes in Aggregate Supply AS3 AS1 Price level AS2 0 Real domestic output, GDP LO2 29-15 Price level (index numbers) Equilibrium AS 100 a 92 b Real Output Demanded (Billions) Price Level (Index Number) Real Output Supplied (Billions) $506 108 $513 508 104 512 510 100 510 512 96 507 514 92 502 AD 0 502 510 514 Real domestic output, GDP (billions of dollars) LO3 29-19 AD Increases: Demand-Pull Inflation Price level AS P2 P1 AD2 AD1 0 Qf Q1 Q2 Real domestic output, GDP LO4 29-20 Decreases in AD: Recession Price level AS P1 P2 b a c AD1 AD2 0 Q1 Q2 Qf Real domestic output, GDP LO4 29-21 Decreases in AD: Recession • Prices are downwardly inflexible (sticky) • Fear of price wars • Menu costs • Wage contracts • Minimum wage law LO4 29-22 Decreases in AS: Cost-Push Inflation Price level AS2 AS1 b P2 P1 a AD 0 Q1 Qf Real domestic output, GDP LO4 29-23 Increases in AS: Full-Employment Price level AS1 P3 P2 P1 AS2 b c a AD2 AD1 0 Q1 Q2 Q3 Real domestic output, GDP LO4 29-24
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