Download Real GDP

Aggregate Demand and
Aggregate Supply
ECONOMICS: Principles and Applications 3e
HALL & LIEBERMAN
© 2005 Thomson Business and Professional Publishing
Figure 1 The Two-Way Relationship
Between Output and the Price Level
Aggregate Demand Curve
Price
Level
Real
GDP
Aggregate Supply Curve
Figure 2 Deriving the Aggregate
Demand Curve
(a)
Interest Rate
9%
6%
Ms
H
As the price level rises, money
demand increases and interest
rate rises.
E
M1d
500
M2d
Money ($ Billions)
Figure 2 Deriving the Aggregate
Demand Curve
(c)
Aggregate Expenditure
($ Trillions)
(b)
Price
Level
E
The rise in the
interest rate
causes real
GDP to fall.
H
6
AEr = 6%
AEr = 9%
10
Real GDP
($ Trillions)
140
H
100
On the AD curve,
a higher price
level is associated
with a lower real
GDP.
E
AD
6
10 Real GDP
($ Trillions)
Movements Along the Aggregate
Demand Curve
P
Increase
in money
demand
r
a and
IP
Multiplier
effect
Equilibrium
GDP
Movements Along the Aggregate
Demand Curve
P
Decrease
in money
demand
r
a and
IP
Multiplier
effect
Equilibrium
GDP
Figure 3 A Spending Shock Shifts
the AD Curve
Real Aggregate Expenditure
($ Trillions)
(a)
(b)
At any given price level, an
increase in government
purchases shifts the AE line
upward, raising real GDP.
AE2
AE1
H
Since real GDP is
higher at the given
price level, the AD
curve shifts rightward.
Price
Level
100
E
H
E
10
AD1 AD2
13.5
Real GDP
($ Trillions)
10 13.5
Real GDP
($ Trillions)
Figure 4a Effects of Key Changes
on the Aggregate Demand Curve
(a)
Price Level
Price level ↑ moves
us leftward along
the AD curve
P3
Price level ↓ moves
us rightward along
the AD curve
P1
P2
AD
Q3
Q1
Q2
Real GDP
Figure 4b Effects of Key Changes
on the Aggregate Demand Curve
(b)
Price Level
Entire AD curve shifts rightward if:
• a, IP, G, or NX increases
• Net taxes decrease
• The money supply increases
AD2
AD1
Real GDP
Figure 4c Effects of Key Changes
on the Aggregate Demand Curve
(c)
Price Level
Entire AD curve shifts rightward if:
• a, IP, G, or NX decreases
decreases
• Net taxes increase
• The money supply decreases
AD1
AD2
Real GDP
Figure 5 The Aggregate Supply
Curve
Price Level
AS
130
B
100
80
Starting at point A, an
increase in output
raises unit costs.
Firms raise prices,
and the overall price
level rises.
A
C
Starting at point A, a decrease
in output lowers unit costs.
Firms cut prices, and the
overall price level falls.
6
10
13.5
Real GDP ($ Trillions)
Movements Upward Along the
Aggregate Supply Curve
Input requirements per unit
of output
Real
GDP
Unit
costs
Prices of nonlabor inputs
Price
level
Movements Downward Along the
Aggregate Supply Curve
Input requirements per unit
of output
Real
GDP
Unit
costs
Prices of nonlabor inputs
Price
level
Figure 6 Shifts of the Aggregate
Supply Curve
AS2
Price Level
140
100
AS1
L
A
10
When unit costs rise at any
given real GDP, the AS curve
shifts upward–e.g., an increase
in world oil prices or bad
weather for farm production.
Real GDP ($ Trillions)
Figure 7a Effects of Key Changes
on the Aggregate Supply Curve
(a)
Price Level
AS
Real GDP ↑ moves
us rightward along
the AS curve
P3
Real GDP ↓ moves
us leftward along
the AS curve
P1
P2
Q2
Q1
Q3
Real GDP
Figure 7b Effects of Key Changes
on the Aggregate Supply Curve
(b)
Price Level
AS2
AS1
Entire AS curve shifts
upward if unit costs ↑ for
any reason besides an
increase in real GDP
Real GDP
Figure 7c Effects of Key Changes
on the Aggregate Supply Curve
(c)
Price Level
AS1
AS2
Entire AS curve shifts
downward if unit costs ↓
for any reason besides
an decrease in real GDP
Real GDP
Figure 8 Short-Run
Macroeconomic Equilibrium
AS
Price Level
B
140
E
100
F
AD
6
10
14
Real GDP ($ Trillions)
Figure 9 The Effect of a Demand
Shock
AS
Price Level
130
115
100
H
J
E
AD1
10
13.5
12.5
AD2
Real GDP($ Trillions)
Increase in Government
Purchases
AD curve shifts rightward
GDP
G
Movement along new AD curve
Unit
costs
P
Movement along AS curve
Money
demand
Interest
rate
a and
IP
GDP
Net Effect: GDP  but by less, due to effect of P 
Decrease in Government
Purchases
AD curve shifts leftward
GDP
G
Movement along new AD curve
Unit
costs
P
Movement along AS curve
Money
demand
Interest
rate
a and
IP
GDP
Net Effect: GDP  but by less, due to effect of P 
Increase in Money Supply
AD curve shifts rightward
Money
Supply
a and
IP
r
GDP
Movement along new AD curve
Unit
costs
P
Movement along AS curve
Money
demand
Interest
rate
a and
IP
GDP
Net Effect: GDP  but by less, due to effect of P 
Figure 10 The Long-Run
Adjustment Process
Price Level
AS2
AS1
P4
K
J
P3
P2
P1
H
E
AD2
AD1
YFE Y3 Y2
Real GDP
Figure 11 Long-Run Adjustment After
a Negative Demand Shock
Price Level
AS1
AS2
P1
P2
E
N
P3
M
AD1
AD2
Y2
YFE
Real GDP
Positive Demand Shocks: Adjusting
to the Long Run
Change in short-run equilibrium
P
and
Y 
Positive
demand shock
Y > YFE
Wage
rate
Unit
costs
Price
Long run adjustment process
Y  until
Y = YFE
Negative Demand Shocks: Adjusting
to the Long Run
Change in short-run equilibrium
P
and
Y
Negative
demand shock
Y < YFE
Wage
rate
Unit
costs
Price
Long run adjustment process
Y  until
Y = YFE
Figure 12 The Long-Run
Adjustment Process
Price Level
Long-Run AS Curve
AS2
AS1
P4
P2
P1
K
H
E
AD2
AD1
YFE
Y2
Real GDP
Figure 13 The Effect of a Supply
Shock
Price Level
Long-Run
AS Curve
AS2
AS1
R
P2
P1
E
AD
Y2
YFE
Real GDP
Figure 14 An AD and AS Analysis of
Two Recessions
Figure 15 GDP and the Price
Level in Two Recessions
Figure 16 The Average Expansion
Versus Two Recent Jobless Expansions