Download BD104_fme_lnt_003_Ma..

LECTURE 3
Aggregate Demand
&
Aggregate Supply
Aggregate Demand
• Aggregate demand is a schedule or curve that
shows the amounts of real output that buyers
collectively desire to purchase at each possible
price level.
Aggregate Demand Curve
Price Level
AD
GDP
Why is the Aggregate Demand Curve Downward
Sloping?
Real-Balances
Effect
Interest-Rate
Effect
Foreign Purchases
Effect
• Real-Balances Effect
(a) A higher price level reduces the real value
or purchasing power of the public’s
accumulated savings balances.
(b) Real value of assets with fixed money values (eg.
savings accounts, bonds etc.) diminishes.
(c) As a result, the public is poorer in real terms and
will reduce spending.
• Interest-Rate Effect
(a) Assume that the supply of money in the economy is fixed.
(b) When price level rises, consumers and businesses need
more money.
(c) So, given a fixed money supply, an increase in money
demand will drive up the price paid for its use. The price is
the interest rate.
(d) Higher interest rate curtail investment spending and
interest-sensitive consumption spending.
(e) By increasing the demand for money, and consequently
the interest rate, a higher price level reduces the amount
of real output demanded.
• Foreign Purchases Effect
(a) When the Malaysian price level rises relative to
foreign price levels (and exchange rates do not
respond quickly or completely), foreigners buy
fewer Malaysian goods and Malaysians buy more
foreign goods.
(b) Therefore, Malaysian exports fall and Malaysian
imports rise.
(c) In short, rise in the price level reduces the
quantity of Malaysian goods demanded as net
exports.
Determinants of Aggregate
Demand
1. Consumer Spending
(a) Consumer wealth
(b) Consumer expectations
(c) Household indebtedness
2. Investment Spending
(a) Real interest rate
(b) Expected returns
3. Government Spending
4. Net Export Spending
(a) National income abroad
(b) Exchange rates
Aggregate Supply
• Aggregate supply is a schedule or curve
showing the level of real domestic output that
firms will produce at each price level.
Aggregate Supply Curve
• There are two types of aggregate supply
curve; which are in the long run and short
run.
Long Run
Short Run
Price Level
AS
GDP
Price Level
AS
GDP
Aggregate Supply in the Long
Run
• When changes in wages respond completely
to changes in the price level, those price-level
changes do not alter the amount of real GDP
produced and offered for sale.
• The long-run aggregate supply curve is
vertical at the economy’s potential output (or
full –employment output).
Aggregate Supply in the Short
Run
• Price-level declines reduce real profits and
cause firms collectively to reduce their output.
• So, in the short run, there is a direct or
positive relationship between the price level
and real output.
Determinants of Aggregate
Supply
• Input Prices
(a) Domestic resource prices
(b) Prices of imported resources
(c) Market power
• Legal-Institutional Environment
(a) Business taxes and subsidies
(b) Government regulation