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Chapter 24
Aggregate Demand
and Supply Analysis
24.1
© 2008 Pearson Education Canada
Aggregate Demand
• Aggregate Demand - The relationship between the
quantity of aggregate output demanded and the
price level when all other variables are
held constant
• Based on the quantity theory of money
– Determined solely by the quantity of money
• Based on the components parts
– Consumption, investment, government spending and net
exports
24.2
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Quantity Theory of Money
Approach to Aggregate Demand
M = quantity of money
P = price level
Y = aggregate real output (real income)
P  Y = total nominal spending on good and services
V = the average number of time per year that a dollar is spent
PY
V
M
Multiplying both sides by M we derive the
equation of exchange which relates the money supply to aggregate spending
M V  P  Y
Changes in aggregate spending are determined primarily by changes
in the money supply
24.3
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Deriving the Aggregate
Demand Curve
• Changes in the price level induce changes in
the aggregate output demanded and hence
movement along the AD curve (points A, B,
and C in Figure 24-1)
• In the quantity theory, changes in the money
supply are the primary source of changes in
aggregate spending and thus shifts the AD
curve.
24.4
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Aggregate Demand Curve
24.5
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Behavior of Aggregate
Demand’s Component Parts
Y  C  I  G  NX
The aggregate demand curve is downward sloping because
ad
P  M / P  i  I  Y 
and
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P  M / P  i  E  NX  Y 
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24.6
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Factors that Shift
Aggregate Demand
• An increase in the money supply shifts AD to
the right because it lowers interest rates and
stimulates investment spending
• An increase in spending from any of
the components C, I, G, NX, will also shift AD
to the right
24.7
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Factors That Shift the
Aggregate Demand Curve
24.8
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Aggregate Supply
• Long-run aggregate supply curve (LRAS)
– Determined by amount of capital and labor and
the available technology
– Vertical at the natural rate of output generated by
the natural rate of unemployment
24.9
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• Short-run aggregate supply curve (SRAS)
– Wages and prices are sticky
– Generates an upward sloping SRAS as firms
attempt to take advantage of short-run
profitability when price level rises
24.10
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Long Run Aggregate Supply
24.11
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Short Run Aggregate Supply
24.12
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Factors that Shift Short
Run Aggregate Supply
• Costs of production
– Tightness of the labor market
– Expected price level
– Wage push
– Change in production costs unrelated to wages
(supply shocks)
24.13
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Factors that Shift Short Run
Aggregate Supply (Cont’d)
24.14
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Equilibrium of AS and AD
in the Short Run
24.15
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Equilibrium of AS and AD
in the Long Run
24.16
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Self-Correcting
Mechanism
• Regardless of where output is initially,
it returns eventually to the natural rate
• Slow
– Wages are inflexible, particularly downward
– Need for active government policy
• Rapid
– Wages and prices are flexible
– Less need for government intervention
24.17
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Response of Output and the Price
Level to a Shift in the AD Curve
24.18
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Response of Output and the Price
Level to a Shift in the AS Curve
24.19
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Shifts in Long-Run
Aggregate Supply
• Economic growth
• Real business cycle theory
– Real supply shocks drive short-run fluctuations in
the natural rate of output (shifts of LRAS)
– No need for government intervention
24.20
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• Hysteresis
– Departure from full employment levels as a result
of past
high unemployment
– Natural rate of unemployment shifts upward and
natural rate of output falls below full employment
– Expansionary policy needed to shift aggregate
demand
24.21
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Conclusions
• Shifts in aggregate demand affects output
only in the short run and has no effect in the
long run
• When shifts in aggregate demand occur, the
initial change in the price level is less in the
short run than it is in the long run when AS
has fully adjusted
24.22
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• Shifts in short run aggregate supply affects
output and price only in the short run and has
no effect in the long run
• The economy has a self-correcting
mechanism
24.23
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Unemployment and Inflation in
the United States 1964 -1970
24.24
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Unemployment and Inflation in
the United States 2000-2004
24.25
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