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Aggregate Demand and Supply Chapter 22. 2 Copyright © Houghton Mifflin Company. All rights reserved. Why the Aggregate Demand Curve Slopes Downward (1)

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Presentation on theme: "Aggregate Demand and Supply Chapter 22. 2 Copyright © Houghton Mifflin Company. All rights reserved. Why the Aggregate Demand Curve Slopes Downward (1)"— Presentation transcript:

1 Aggregate Demand and Supply Chapter 22

2 2 Copyright © Houghton Mifflin Company. All rights reserved. Why the Aggregate Demand Curve Slopes Downward (1) Aggregate demand (AD) is the economy-wide demand for goods and services. Like the market demand curve, the aggregate demand curve slopes downward, but for different reasons. The reasons for its downward slope are price-level effects: – Wealth Effect (Real Wealth/Real Balances) – Interest Rate Effect – International Trade Effect (Substitution)

3 3 Copyright © Houghton Mifflin Company. All rights reserved. Why the Aggregate Demand Curve Slopes Downward (2)

4 4 Copyright © Houghton Mifflin Company. All rights reserved. The Interest Rate Effect

5 5 Copyright © Houghton Mifflin Company. All rights reserved. Why the Aggregate Demand Curve Slopes Downward (4)

6 6 Copyright © Houghton Mifflin Company. All rights reserved. The Aggregate Demand Curve Note that changes in prices result in changes in the aggregate quantity demanded.

7 7 Copyright © Houghton Mifflin Company. All rights reserved. Factors that Affect AD Consumption – Income – Wealth – Expectations – Demographics – Taxes Investment – Interest Rates – Technology – Cost of Capital Goods – Capacity Utilization AD = C + I + G + X N Government Spending Net Exports – Domestic & Foreign Income – Domestic & Foreign Prices – Exchange Rates – Government Policy

8 8 Copyright © Houghton Mifflin Company. All rights reserved. Non-price Determinants: Changes in Aggregate Demand (1)

9 9 Copyright © Houghton Mifflin Company. All rights reserved. Nonprice Determinants: Changes in Aggregate Demand (2)

10 10 Copyright © Houghton Mifflin Company. All rights reserved. Non-price Determinants: Changes in Aggregate Demand (3)

11 11 Copyright © Houghton Mifflin Company. All rights reserved. Shifting the Aggregate Demand Curve

12 12 Copyright © Houghton Mifflin Company. All rights reserved. Effects of a Change in Aggregate Demand Demand-pull inflation: rapid increases in AD outpace the growth of AS, causing price level increases (inflation).

13 13 Copyright © Houghton Mifflin Company. All rights reserved. Short-run Aggregate Supply Aggregate Supply (AS) is the total of all the firm (market) supply curves. It shows the quantity of real GDP produced at different price levels. Short-run AS slopes upward because an increase in the price level (while production costs and capital are held constant on the short-run), means higher profit margins—firms will want to produce more.

14 14 Copyright © Houghton Mifflin Company. All rights reserved. Aggregate Supply

15 15 Copyright © Houghton Mifflin Company. All rights reserved. Shape of Short-run AS (SRAS) In the short-run, the capital stock (the number of factories and machines, etc.) are held constant. Increasing the number of workers increases output, but at a diminishing rate. Diminishing returns manifest as an ever-steeper SRAS curve. In the short-run, some prices do not adjust quickly: – Labor Costs (wages) – Contracted supplies – “Sticky” prices effect the short-run equillibrium

16 16 Copyright © Houghton Mifflin Company. All rights reserved. The Shape of the Short-Run Aggregate Supply Curve

17 17 Copyright © Houghton Mifflin Company. All rights reserved. The Shape of Long-run AS (LRAS) Resource costs are NOT fixed. – As prices rise, workers will want higher wages and will eventually get them. The amount of capital is not fixed—firms can build new plants and buy new equipment over the long-run. In the long-run, AS is set by the production possibilities curve—the capacity of the economy, and is not affected by prices, hence is vertical.

18 18 Copyright © Houghton Mifflin Company. All rights reserved. The Shape of the Long-Run Aggregate Supply Curve

19 19 Copyright © Houghton Mifflin Company. All rights reserved. Determinants of Aggregate Supply (1)

20 20 Copyright © Houghton Mifflin Company. All rights reserved. Determinants of Aggregate Supply (2)

21 21 Copyright © Houghton Mifflin Company. All rights reserved. Determinants of Aggregate Supply (3)

22 22 Copyright © Houghton Mifflin Company. All rights reserved. Shifting the Long-Run Aggregate Supply Curve Growth occurs as the labor force and the capital stock grow, as technological innovation improves production efficiency.

23 23 Copyright © Houghton Mifflin Company. All rights reserved. Changes in Short-Run Aggregate Supply

24 24 Copyright © Houghton Mifflin Company. All rights reserved. Effects of a Change in Aggregate Supply Cost-push inflation: cost increases push AS to the left (relative to AD), causing price level increases (inflation).

25 25 Copyright © Houghton Mifflin Company. All rights reserved. Aggregate Demand and Aggregate Supply Equilibrium

26 26 Copyright © Houghton Mifflin Company. All rights reserved. Aggregate Demand and Supply Equilibrium

27 27 Copyright © Houghton Mifflin Company. All rights reserved.

28 28 Copyright © Houghton Mifflin Company. All rights reserved.

29 29 Copyright © Houghton Mifflin Company. All rights reserved.

30 30 Copyright © Houghton Mifflin Company. All rights reserved.

31 31 Copyright © Houghton Mifflin Company. All rights reserved.

32 32 Copyright © Houghton Mifflin Company. All rights reserved.

33 33 Copyright © Houghton Mifflin Company. All rights reserved. Economic Insight: OPEC and Aggregate Supply


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