1. Aggregate Demand and
Aggregate
Supply

2. Chapter Objectives
Aggregate Demand and the Factors That Cause it to Change
Aggregate Supply and the Factors That Cause it to Change
How AD and AS Determine an Economy’s Equilibrium Price Level and the Level of Real GDP
How the AD-AS Model Explains Periods of Demand-Pull Inflation, Cost-Push Inflation, and Recession

3. AD – AS Model Aggregate Demand
AD is a schedule, graphically represented as a curve, which shows the various amounts of goods and services – the amount of real domestic output – which domestic consumers, businesses, government and foreign buyers collectively will desire to purchase at each possible price level.

4. AGGREGATE DEMAND CURVE
Price level AD
Real domestic output, GDP

5. AD – AS Model Why the Downward Slope? Real-Balances Effect
Interest-Rate Effect
Foreign Purchases Effect

6. Why the Downward Slope? Real-Balances Effect / Wealth Effect
A higher price level will reduce the real value or purchasing power of the public’s accumulated financial assets

7. Why the Downward Slope? Interest-Rate Effect
A higher price level – by increasing the demand for money and the interest rate – reduces the amount of real output demanded.
The AD curve assumes that the supply of money in the economy is fixed.

8. Why the Downward Slope? Foreign Purchases Effect
The volume of imports and exports depend on, among other things, relative price level in the country and abroad.
Thus if the price level rises in Pakistan relative to foreign countries, Pakistani buyers will buy more imports at the expense of domestic goods. Similarly, foreigners will buy fewer Pakistani goods, reducing Pakistan’s exports

9. Changes in Aggregate Demand
Law of Demand
An increase in the price level, other things being equal, will decrease the quantity of real output demanded.
Determinants of Aggregate Demand (Other Things)

10. Determinants of Aggregate Demand
Changes in:
Consumer Spending
Consumer Wealth
Consumer Expectations
Household Debt
Personal Taxes
Investment Spending
Real Interest Rates

11. Changes in Aggregate Demand
Expected Returns
About Future Business Conditions
Technology
Degree of Excess Capacity
Business Taxes
Government Spending
Net Export Spending
National Income Abroad
Exchange Rates

12. Changes in Aggregate Demand
Increase in
Aggregate
Demand
Price Level
Decrease in
Aggregate
Demand
AD2
AD1
AD3
Real Domestic Output, GDP

13. AGGREGATE SUPPLY Levels of Real Domestic Output
At Each Possible Price Level
Long-run Supply Curve
Wages and Resource Prices Match Price Level
Short-run Supply Curve
Wages and Resource Prices Do Not Match Price Level

14. Long Run P ASLR Q Price level Long-run Aggregate Supply
Full-Employment Qf Q
Real domestic output, GDP

15. AGGREGATE SUPPLY Short Run P AS Q Aggregate Supply Short-run
Price level
Full-
Employment Q Qf
Real domestic output, GDP

16. AGGREGATE SUPPLY Changes in Aggregate Supply P Q Decrease In Aggregate
Price level
Increase In
Aggregate
Supply Q
Real domestic output, GDP

17. Input Prices Domestic Resource Prices Labor Land Capital
DETERMINANTS OF AGGREGATE SUPPLY
Input Prices
Domestic Resource Prices
Labor
Land
Capital
Prices of Imported Goods
Market Power

18. Legal-Institutional Environment
DETERMINANTS OF AGGREGATE SUPPLY
Productivity
Productivity =
Total Output
Total Inputs
Legal-Institutional Environment
Business Taxes and Subsidies
Government Regulation

19. Equilibrium and Changes in Equilibrium
The equilibrium price level and amount of real domestic output are determined at the intersection of the AD and AS curves.

20. Equilibrium Price Level and Equilibrium Price Level
Real Output
Demanded
(Billions)
Real Output
Supplied
(Billions)
Price Level
(Index Number)
$506
508
510
512
514
108
104
100 96 92
$513
512
510
507
502
Equilibrium Price Level and
Equilibrium Price Level

21. Equilibrium and Changes in EquilibriumAS
Price Level
Equilibrium
100 92 a b AD
502
510
514
Real Domestic Output, GDP
(Billions of Dollars)

22. Equilibrium and Changes in Equilibrium
Increase in Aggregate Demand AS
Demand-Pull
Inflation P2
Price Level P1
AD1 AD Qf Q1 Q2
Real Domestic Output, GDP

23. DECREASES IN AD: RECESSION & CYCLICAL UNEMPLOYMENTb a P1
Price Level c Q Q1 Qf
Real Domestic Output, GDP

24. Equilibrium and Changes in Equilibrium
Decrease in Aggregate Supply
AS1 AS
Cost-Push
Inflation b P2
Price Level a P1 AD Q1 Qf
Real Domestic Output, GDP

25. Aggregate Demand Curve Aggregate Expenditures Model
Derivation of the
Aggregate Demand Curve
from the
Aggregate Expenditures Model …

26. Aggregate expenditures
DERIVATION OF THE AGGREGATE DEMAND CURVE
AE1 at P 1 1
AE2 at P 2
AE3 at P 3
Aggregate expenditures
(billions of dollars) 2 3 Q3 Q2 Q1 3’ P3
The Aggregate Demand
Can Be Constructed
Price level 2’ P2 1’ P1 AD Q3 Q2 Q1
Real Domestic Output

27. Increase in Aggregate Expenditures Increase in Aggregate Demand
SHIFTS IN THE AGGREGATE EXPENDITURES
SCHEDULE & THE AGGREGATE DEMAND CURVE
AE2 at P 1
AE1 at P 1
Aggregate expenditures
(billions of dollars)
Increase in
Aggregate
Expenditures Q1 Q2
Increase in
Aggregate
Demand
Price level P1
AD2
AD1 Q1 Q2
Real Domestic Output

28. SUMMARY
AD reflects an inverse relationship between the price level and the amount of real domestic output demanded.
Changes in the price level produce wealth, interest rate, and foreign purchases effects which explain the downward slope of the AD curve.
Changes in one or more of the determinants of AD alter the amounts of real domestic output demanded at each price level; they shift the AD curve.
An increase in AD is shown as a rightward shift of the AD curve; a decrease entails a leftward shift of the curve.

29. Quick Review
The equilibrium price level and amount of real domestic output are determined at the intersection of the AD and AS curves.
Increase in the AD in upsloping and vertical ranges of AS cause Demand Pull Inflation.
Decrease in AS curve cause Cost push inflation.
Increase in AS expand real domestic output; they result in economic growth.