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Chapter 22
Aggregate Demand
and Aggregate Supply
©2000 South-Western College Publishing
GDP Deflator
A price index that measures
the overall changes in prices
of everything in GDP
2
Aggregate Demand Curve
Shows an inverse relationship
between the overall price level
and the quantity of real
output that will be demanded
at various price levels, ceteris
paribus
3
The Aggregate Demand Curve
Price
Index
1.05
1.00
.95
AD
Real GDP (billions)
$1,300 $1,500 $1,700
Exhibit 22 - 1
4
Why the Aggregate Demand
Curve Slopes Downward
1. The real balance or wealth
effect
2. The substitution of foreign
goods effect
3. The constant nominal income
effect
Exhibit 22 - 2
5
Wealth Effect, or Real
Balances Effect
The change in the supply of
real balances, which causes
an increase or decrease in
wealth, when the price level
changes for a given supply of
nominal money balances
6
Substitution-of-Foreign
Goods Effect
When changes in the domestic
price level cause consumers to
substitute into relatively cheaper
foreign goods or out of relatively
more expensive foreign goods
7
Constant Nominal Income
Effect
When changes in the price
level necessarily cause the
quantity demanded to change
in the opposite direction to
maintain the constant
nominal purpose
8
The Shift in Aggregate Demand Curve
Price
Index
A
A'
1.0
AD'
AD
Real GDP in billions
$1,500
Exhibit 22 - 3
$2,000
9
U.S. Monetary
Policy
U.S. Fiscal
Policy
Foreign Policies &
Developments
Money Supply
Interest Rates
Government
Spending & Taxes
Exchange Rates
Capital Flows
Interest Rates, Stock
Prices, Exchange Rates,
Expected Inflation,
Economic Outlook
Consumption
Investment
Government
Net Exports
Aggregate Demand & Income
Exhibit 22 - 4
10
Aggregate Supply Curve
The curve graphically depicting
the relationship between the
overall price level and the
quantity of real GDP that will
be supplied at various price
levels
11
Long-Run Equilibrium
When all prices, including
wages, have fully adjusted to
previous shifts in aggregate
supply or demand and the flow
of spending, saving, borrowing
and lending continues until
something else changes
12
Real Wage =
nominal wage
overall price level
13
Short-Run Aggregate
Supply Curve
Shows the direct relationship
between the overall price level
and the level of real output that
will be supplied in response to
changes in demand before full
adjustment of relative price has
taken place
14
Natural Level of Real
Output
The level of real output that
is consistent with long-run
equilibrium given the
economy’s quantity and
productivity of the factors of
production
15
Short Run Aggregate Supply
Price
Index
SRAS
B
1.05
1.00
.95
A
C
AD'
AD
AD''
Exhibit 22 - 5
$1,300 $1,500 $1,700
Real GDP (billions)
16
Determinants of the Natural
Level of Real Output
1. The economy’s capital stock
2. Natural resources
4. The labor force
3. Technological know-how
4. Institutional arrangements
concerning the labor market
and other input markets
17
Exhibit 22 - 6
Long-Run Aggregate
Supply Curve
The vertical curve through
the natural rate of output to
which the economy will
return in the long run,
regardless of the price level
18
The Long-Run Aggregate Real Supply
Price
Index
LRAS
B
1.10
AD'
1.0
A
AD
Real GDP
Exhibit 22 - 7
19
Shifts in Short-Run Aggregate Supply
Price
Index
SRAS''
SRAS'
SRAS
LRAS
D
1.10
C
B
1.05
1.00
A
AD'
AD
$1,500 $1,700
Real GDP in billions
Exhibit 22 - 8
20
Demand-Pull Inflation
Sustained increases in the
overall price level due to high
levels of demand
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Net Incurring of
Financial Liabilities
The incurring of debt
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Net Acquisition of
Financial Assets
The purchasing of
financial assets
23
Net Financial Investment
When the net acquisition of
financial assets is greater than
the net incurring of financial
liabilities within a given sector
24
Net Financial Deficit
When the net incurring of
financial liabilities is greater
than the net acquisition of
financial assets within a given
sector
25