1. Aggregate Demand and Supply

2. Aggregate Demand Macro concept – WHOLE economy Formula:
The sum of all expenditure in the economy over a period of time
Macro concept – WHOLE economy
Formula:
AD = C+I+G+(X-M)
C= Consumption Spending
I = Investment Spending
G = Government Spending
(X-M) = difference between spending on imports and receipts from exports (Balance of Payments)

3. Aggregate Demand Curve
Shows the overall level of spending at different price levels
Note – Inflation used for the vertical axis (Assumes Central Banks do not target the money supply but short term interest rates)

4. Aggregate Demand Curve
Why does it slope down from left to right?
Assume Bank of England sets short term interest rates
Assume a rise in the price level will be met by a rise in interest rates
Any increase in interest rates will raise the cost of borrowing:
Consumption spending will fall
Investment will fall
International competitiveness will decrease – exports fall, imports rise
Therefore – a rise in the price level leads to lower levels of aggregate demand

5. Aggregate Demand Curve
The AD diagram:
Inflation on the vertical axis – assume an initial ‘target rate’ of 2.0% (as measured by the HICP or CPI)
Real GDP or Real National Income or Real Output on the vertical axis (shown by the initial Y)

6. Aggregate Demand Curve
The lower level of National Income requires fewer units of labour – unemployment rises to 7% shown by U = 7%
At a higher rate of inflation (3.0%) rising interest rates mean that C, I and (X-M) all have negative effects on AD – NY falls to Y2
Inflation
This level of output will be associated with a particular level of unemployment which we will call U = 5%
At an inflation level of 2%, the AD curve gives a level of output of Y1
3.0%
2.0% AD Y2 Y1
Real National Income
U = 7%
U = 5%

7. Shifts in the Aggregate Demand Curve
Any exogenous factor causing C, I or G to rise, or a trade surplus causes a shift to the right in AD
This would cause a rise in national income (economic growth) and lead to a fall in unemployment (U = 2%) (and vice versa)
Shifts in AD will be
caused
by changes in factors
affecting C, I, G and
(X-M)
(exogenous factors)
e.g. increasing income tax
rates affect consumption
Inflation
2.0%
AD2 AD Y1 Y2
Real National Income
U = 5%
U = 2%

8. Consumption Expenditure affected by
Tax rates
Incomes – short term and expected income over lifetime
Wage increases
Credit
Interest rates
Wealth

9. Investment Expenditure
Spending on:
Machinery
Equipment
Buildings
Infrastructure
Influenced by:
Expected rates of return
Interest rates
Expectations of future sales
Expectations of future inflation rates

10. Government Spending Defence Health Social Welfare Education
Foreign Aid
Regions
Industry
Law and Order

11. Import Spending (negative)
Goods and services bought from abroad – represents an outflow of funds from the UK (reduces AD)

12. Export Earnings (Positive)
Goods and services sold abroad – represents a flow of funds into the UK (raises AD)

13. Key variables

14. Macroeconomic policy

15. Fiscal Policy Government Income (taxes and borrowing)
Government Spending

16. Monetary Policy
Interest Rates (Bank of England)

17. Aggregate Supply (AS)

18. Capacity of the Economy
Costs of Production
Technology
Education and Training
Incentives
Tax regime
Capital stock
Productivity
Labour Market

19. Aggregate Supply Inflation AS
Between Y1 and Yf, increases in capacity are possible but the nearer the economy gets to Yf, the more problems are experienced with acquiring resources to boost production (production bottlenecks) especially labour skills shortages.
An output level of Y1 would suggest the economy is working below full capacity and there would be widespread unemployment
Yf represents ‘Full Employment Output – at this point the economy is working to full capacity and cannot produce any more
The shape of the AS
curve is important in
determining the
outcome
in the economy
This shape reflects a Keynesian view of the AS curve.
Economy starts to overheat Y1 Yf
Real National Income

20. Aggregate Supply Inflation AS1 AS2 Yf1 Yf2 Real National Income
Increases in capacity can occur as a result of a shift in AS (akin to a shift outwards of the Production Possibility Frontier) (PPF)
Yf1
Yf2
Real National Income

21. Aggregate Supply Inflation LRAS Yf Real National Income
This is because they believe that in the long run, there will be no unemployment of resources because markets will clear, thus whatever the rate of inflation, firms will supply the maximum capacity of the economy.
Classical economists assume the long run aggregate supply curve (LRAS) is vertical (perfectly inelastic). Yf
Real National Income

22. Aggregate Supply AS Inflation Real National Income
For our analysis, we will assume the AS curve looks like this!
Real National Income

23. Putting AD and AS together
A shift in the AD curve to AD1 as a result of a change in any or all of the factors affecting AD would increase growth, reduce unemployment but at a cost of higher inflation (a trade-off)
Inflation
In this situation, the economy would be operating at less than capacity, there would be unemployment and the economy might be growing only slowly.
2.5%
2.0%
AD 1 AD Y1 Y2 Yf
Real National Income

24. Putting AD and AS together
Further increases in AD would lead to successively smaller increases in growth and employment at the cost of ever higher inflation.
Inflation
3.5%
AD2
2.5%
2.0%
AD1 AD Y1 Y2 Yf Y3
Real National Income

25. Sustained Growth Inflation AS AS1 2.0% AD2 AD Y1 Y2
Sustained growth (not to be confused with sustainable economic growth) occurs when AS and AD rise at similar rates – national income can rise without effects on inflation
2.0%
AD2 AD Y1 Y2
Real National Income

26. Research - Homework
Research the following indicators (get sources) for Kazakhstan and prepare a presentation on the Kazakh Economy.
How well is the Kazakh Economy Doing?
You may use one or more of the following indicators, or another indicator to best answer the above questions.
GDP
GNP
NNP (Net National Development Index)
HDI (Human Development Index)
Possible sources