11 C H A P T E R Aggregate Demand and Aggregate Supply

AGGREGATE DEMAND Defined: The amounts of real output that buyers collectively desire to purchase at each possible price level Aggregate Demand Curve Down Sloping Due To: Real-Balances Effect Interest-Rate Effect Foreign Purchases Effect

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 GDP3 GDP2 GDP1 3’ P3 The Aggregate Demand Can Be Constructed Price level 2’ P2 1’ P1 AD GDP3 GDP2 GDP1

CHANGES IN AGGREGATE DEMAND Can Increase Price level AD2 AD1 Real domestic output, GDP

CHANGES IN AGGREGATE DEMAND Can Increase …or Decrease Price level AD1 AD3 Real domestic output, GDP

Change in Consumer Spending DETERMINANTS OF AGGREGATE DEMAND Change in Consumer Spending Consumer Wealth Consumer Expectations Consumer Indebtedness Taxes Change in Investment Spending Real Interest Rates Expected Returns Expected Future Business Conditions Technology Degree of Excess Capacity Business Taxes

Government Spending Net Export Spending National Income Abroad DETERMINANTS OF AGGREGATE DEMAND Government Spending Net Export Spending National Income Abroad Exchange Rates Changes in Aggregate Demand Shifts and the Aggregate Expenditures Model Illustrated…

Increase in Aggregate Expenditures Increase in Aggregate Demand SHIFTS IN THE AGGREGATE EXPENDITURES SCHEDULE & THE AGGREGATE DEMAND CURVE AE2 at P 2 AE1 at P 1 Aggregate expenditures (billions of dollars) Increase in Aggregate Expenditures GDP1 GDP2 Increase in Aggregate Demand Price level P1 AD2 AD1 GDP1 GDP2

AGGREGATE SUPPLY Defined: The amounts of real output that firms will produce at each possible price level Higher Price Levels Provide An Incentive to Produce More Aggregate Supply Has Three Segments or Ranges: 1 - Horizontal Range 2 - Intermediate (Upsloping) Range 3 - Vertical Range

AGGREGATE SUPPLY P Q Vertical Range Price level Upsloping or Horizontal Range Upsloping or Intermediate Range Q Real domestic output, GDP

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

Domestic Resource Availability Land Labor Capital DETERMINANTS OF AGGREGATE SUPPLY Change in Input Prices Domestic Resource Availability Land Labor Capital Entrepreneurial Ability Prices of Imported Goods Market Power

Change in Productivity DETERMINANTS OF AGGREGATE SUPPLY Change in Productivity Productivity = Real Output Input Change in Legal-Institutional Environment Business Taxes and Subsidies Government Regulation

EQUILIBRIUM: REAL OUTPUT AND THE PRICE LEVEL P AS Equilibrium in the Intermediate Range Price Level Pe P1 AD Q Q1 Qe Q2 Real Domestic Output, GDP

EQUILIBRIUM: REAL OUTPUT AND THE PRICE LEVEL P AS Equilibrium in the Horizontal Range Price Level Pe AD Q Q1 Qe Q2 Real Domestic Output, GDP

CHANGES IN EQUILIBRIUM Increasing Demand in the Horizontal Range P AS AD1 Price Level P1 AD2 Q Q1 Q2 Real Domestic Output, GDP

CHANGES IN EQUILIBRIUM Increasing Demand in the Intermediate Range P AS Price Level P4 P3 AD3 AD4 Q Q3 Q4 Real Domestic Output, GDP

CHANGES IN EQUILIBRIUM Increasing Demand in the Vertical Range P AS P6 Price Level P5 AD6 AD5 Q Qc Real Domestic Output, GDP

MULTIPLIER WITH PRICE-LEVEL CHANGES Inflation and the Multiplier Full Multiplier Effect AS Reduced Multiplier Effect Due to Inflation Price Level P2 P1 AD3 AD2 AD1 GDP1 GDP2 GDP3 Real Domestic Output, GDP

DECREASES IN AD AND RECESSION Decreasing Demand That Causes A Recession Recession and Cyclical Unemployment Wage Contracts Morale, Effort, and Productivity Efficiency Wages Minimum Wage Menu Costs Fear of Price Wars

DECREASES IN AD AND RECESSION Decreasing Demand That Causes A Recession AS AD2 Price Level P1 AD1 Q2 Q1 Real Domestic Output, GDP

DECREASES IN AD AND RECESSION Decreasing Supply That Causes A Recession AS2 AS1 P2 Price Level P1 AD Q2 Q1 Real Domestic Output, GDP

INCREASES IN AS AND INFLATION Increasing Supply: Full-Employment and Price-Level Stability AS1 AS2 P3 Price Level P2 P1 AD2 AD1 Q1 Q2 Q3 Real Domestic Output, GDP

INCREASES IN AS AND INFLATION Increasing Supply: Full-Employment and Price-Level Stability AS1 AS2 Chapter Conclusions P3 Price Level P2 P1 AD2 AD1 Q1 Q2 Q3 Real Domestic Output, GDP

KEY TERMS aggregate demand-aggregate supply (AD-AS) model real-balances effect interest-rate effect foreign purchases effect determinants of aggregate demand aggregate supply horizontal range (of AS curve) intermediate range (of AS curve) vertical range (of AS curve) determinants of aggregate supply productivity equilibrium price level equilibrium real output efficiency wages menu costs BACK END Copyright McGraw-Hill/Irwin, 2002

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