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Principles of Macroeconomics
Lecture 4
BUSINESS CYCLES AND AGGREGATE DEMAND
Aims
- To describe the short-term fluctuations in output,
employment and prices that characterize business
cycles in market economies
- To explain the concept of aggregate demand
and the differences from a single commodity
demand
Business Cycles
-are swings in total national output, income and
employment,
- are marked by widespread expansion or
contraction in many sectors of the economy,
-occur in all advanced market economies, and
- consist of four phases.
The Business Cycles Theory
Business Cycles Phases and Turning Points
PHASES
-Expansion: A period in which GDP increases
for two consecutive quarters
-Recession: A period in which GDP declines for
two consecutive quarters
TURNING POINTS
- Peak: The highest point of the expansion phase
- Trough: The lowest point of recession phase
Business Cycles Phases
- Characteristics of Expansion:
- Consumption rises
- Business inventories decrease
- Production is increased
- Real GDP rises
- Business investment rises
- Labour demand increases and unemployment falls
- Inflation becomes high
- Interest rate rises
Business Cycles Phases
- Characteristics of Recession:
- Consumption falls sharply
- Business inventories increase
- Production is reduced
- Real GDP falls
- Business investment falls
- Labour demand falls and unemployment rises
- Inflation slows
- Interest rate falls
Definition of Aggregate Demand
- Aggregate Demand (AD) is the total or aggregate
quantity of output that is willingly bought at a
given level of prices
- It has four components:
- Consumption
- Investment
- Government Purchases
- Net Exports
- Remember the GDP equation : Y= C+I+G+ (X-M)
Differences of AD with the micro demand
- AD curves relate overall spending on all
components of output to the overall price level
- AD is downward sloping mainly due to the
money-supply effect. That is when a rise in the
price level occurs, the real money supply is
reduced (all others held constant). Thus interest
rates rise, credit is difficult to obtain and total real
spending falls.
The Aggregate Demand (AD) Curve
Factors affecting Aggregate Demand
-Monetary and fiscal policy
-Exogenous variables such as foreign economic
activity, technological advances and shifts in asset
markets
- Changing these variables shifts the AD curve
Movements and Shifts in AD
Factors affecting Aggregate Demand
Key things to remember:
-A change at the price level leads to a
MOVEMENT along the AD curve
- A change in other underlying factors of AD leads
to a SHIFT of the AD curve

Aggregate Supply
The aggregate
supply curve is
upward sloping.
Macroeconomics

A Shift in Aggregate Supply
According to
Classical theory,
an increase in AS
increases GDP, and
lowers the price
level.
Macroeconomics
Helpful reading
Economics. Samuelson, & Nordhaus (2005) Ch. 23