1. Introduction to AD/AS Model
Aggregate Demand
Introduction to AD/AS Model
Most important model in AP Macro

2. Aggregate Supply & Demand Model
Economists developed the AS/AD model to explain short-run fluctuations in Real GDP around its long-run trend
Time
Economic activity
(Real GDP)
Business cycle
Long Run
“full potential”
Trend Line

3. AS & AD Model Price Level Real GDP (or output )
A measure of inflation (think CPI or GDP deflator)
Real GDP (or output )
economy’s output of final goods and services

4. Aggregate Demand
Aggregate-demand curve (AD)- how demand for the entire economy changes with inflation (price level)
demand from households, firms, exports & government at each price level
4 Components of AD : AD = C + I + G + NX
AD = C + I + G + NX

5. Shifts in AD Curve
Shifts arise from changes in any of the 4 Determinants of AD
Consumption
Investment
Government Purchases
Net Exports
AD = C + I + G + NX

6. 3 Reasons AD is Downward Sloping
AD = C + I + G + NX

7. Wealth Effect (consumption)
As price level falls => real value of wealth/savings ↑
Consumers feel wealthier (purchasing power ↑) => spend more!
Y = C + I + G + NX

8. Interest Rate Effect (Investment)
A lower price level lowers real interest rates
Why: consumers “hold” less money (save more money)
More savings leads to lower real interest rates which raises
Y = C + I + G + NX

9. Exchange Rate Effect
A lower price level makes U.S. goods cheaper to foreigners
Reduced “price” leads to more EXPORTS (U.S. exports look cheap!)
Y = C + I + G + NX
NX ↑

10. Worksheet Part I