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Aggregate Demand and Aggregate Supply Chapter Objectives Aggregate Demand and the Factors That Cause it to Change Aggregate Demand and the Factors That.

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Presentation on theme: "Aggregate Demand and Aggregate Supply Chapter Objectives Aggregate Demand and the Factors That Cause it to Change Aggregate Demand and the Factors That."— Presentation transcript:

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2 Aggregate Demand and Aggregate Supply

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

4 AD – AS Model Aggregate Demand 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. 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.

5 AGGREGATE DEMAND CURVE Price level Real domestic output, GDP AD

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

7 Why the Downward Slope? Real-Balances Effect / Wealth Effect Real-Balances Effect / Wealth Effect A higher price level will reduce the real value or purchasing power of the publics accumulated financial assets A higher price level will reduce the real value or purchasing power of the publics accumulated financial assets

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

9 Why the Downward Slope? Foreign Purchases Effect Foreign Purchases Effect The volume of imports and exports depend on, among other things, relative price level in the country and abroad. 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 Pakistans exports 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 Pakistans exports

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

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

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

13 Changes in Aggregate Demand Real Domestic Output, GDP Price Level AD 1 Increase in Aggregate Demand AD 3 AD 2 Decrease in Aggregate Demand

14 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

15 Price level Real domestic output, GDP Q P Long Run AS LR Long-run Aggregate Supply QfQf Full-Employment

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

17 AGGREGATE SUPPLY Price level Real domestic output, GDP Q P AS 3 AS 1 AS 2 Increase In Aggregate Supply Decrease In Aggregate Supply Changes in Aggregate Supply

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

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

20 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. The equilibrium price level and amount of real domestic output are determined at the intersection of the AD and AS curves.

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

22 Equilibrium and Changes in Equilibrium Real Domestic Output, GDP (Billions of Dollars) Price Level 100 92 502510514 a b AD AS Equilibrium

23 Equilibrium and Changes in Equilibrium Real Domestic Output, GDP Price Level AD AS P1P1 P2P2 Q2Q2 Q1Q1 QfQf AD 1 Increase in Aggregate Demand Demand-Pull Inflation

24 Price Level Real Domestic Output, GDP Q P AS AD 1 DECREASES IN AD: RECESSION & CYCLICAL UNEMPLOYMENT P1P1 AD 2 QfQf Q1Q1 a c b

25 Equilibrium and Changes in Equilibrium Real Domestic Output, GDP Price Level AD AS P1P1 P2P2 Q1Q1 QfQf Decrease in Aggregate Supply Cost-Push Inflation AS 1 a b

26 Derivation of the Aggregate Demand Curve from the Aggregate Expenditures Model …

27 Aggregate expenditures (billions of dollars) 0 0 Price level Q1Q1 P1P1 AE 1 at P 1 1 1 P2P2 AE 2 at P 2 2 2 AE 3 at P 3 3 P3P3 3 The Aggregate Demand Can Be Constructed DERIVATION OF THE AGGREGATE DEMAND CURVE Q3Q3 Q2Q2 Q1Q1 Q3Q3 Q2Q2 AD Real Domestic Output

28 Aggregate expenditures (billions of dollars) 0 0 Price level Q2Q2 AE 2 at P 1 P1P1 AE 1 at P 1 SHIFTS IN THE AGGREGATE EXPENDITURES SCHEDULE & THE AGGREGATE DEMAND CURVE Q1Q1 Q2Q2 Q1Q1 AD 1 AD 2 Increase in Aggregate Expenditures Increase in Aggregate Demand Real Domestic Output

29 SUMMARY AD reflects an inverse relationship between the price level and the amount of real domestic output demanded. 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 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. 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. An increase in AD is shown as a rightward shift of the AD curve; a decrease entails a leftward shift of the curve.

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


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