1. 13_14:Aggregate Supply and Aggregate Demand
What is the purpose of the aggregate supply-aggregate demand model?
What determines aggregate supply and aggregate demand?
This discussion follows nicely from the tutorial EIA
I have included many extra slides to minimize the notes you will have to take.
Plan to spend a lot of class time discussing the AS-AD model.
Point out to students that they should not expect to understand all the details of the model after this chapter. Many of the underlying points will be made in future chapters. They should concentrate on developing an intuitive understanding of how the model works.
Make the analogy between the microeconomic demand and supply curves and the AD and AS curves of this chapter.

2. The Aggregate Supply-Aggregate Demand Model
The purpose of this model is:
to help understand and predict fluctuations of real GDP around potential GDP
to understand and predict fluctuations in the price level
next slide is a copy taken from lecture 8

3. Fig. 5.2 (22.2) 21

4. Aggregate Supply
The aggregate quantity of goods and services supplied is the sum of the quantities of final goods and services produced by all firms in the economy (real GDP).
Aggregate supply is the relationship between the quantity of real GDP supplied and the price level.

5. Aggregate Supply
The aggregate production function shows that the quantity of real GDP supplied is determined by the quantities of labor and capital and the state of technology.

6. Aggregate Supply
Capital and technology are fixed at any point in time.
However, labor is not fixed.
Lower wages result in a greater quantity of labor demanded
Higher wages result in a greater quantity of labor supplied

7. Aggregate Supply Full Employment
Occurs at the wage rate that makes the quantity of labor demanded equal to the quantity of labor supplied

8. Aggregate Supply Natural Rate of Unemployment
The unemployment rate that exists at full employment
In 1997 it was about 5.5%
It is probably much lower (e.g. 4%) today.

9. Aggregate Supply
Potential GDP is the quantity of real GDP supplied when unemployment is at its natural rate and there is full employment.

10. Aggregate Supply Long-Run Aggregate Supply
The macroeconomic long run is a time frame that is sufficiently long for forces that move real GDP toward potential GDP to have done their work so that full employment prevails.

11. Aggregate Supply Long-Run Aggregate Supply
The long-run aggregate supply curve is the relationship between the quantity of real GDP supplied and the price level in the long run when real GDP equals potential GDP.

12. Long-Run Aggregate Supply
140
130
120
Price level (GDP deflator, 1992 = 100)
110
100
Instructor Notes:
1) The long-run aggregate supply (LAS) curve shows the relationship between potential GDP and the price level.
2) Potential GDP is independent of the price level, so the LAS curve is vertical at potential GDP. 90
6.0
6.5
7.0
7.5
8.0
8.5
Real GDP (trillions of 1992 dollars)

13. Long-Run Aggregate Supply
LAS
140
130
120
Price level (GDP deflator, 1992 = 100)
110
100
Instructor Notes:
1) The long-run aggregate supply (LAS) curve shows the relationship between potential GDP and the price level.
2) Potential GDP is independent of the price level, so the LAS curve is vertical at potential GDP.
Potential
GDP 90
6.0
6.5
7.0
7.5
8.0
8.5
Real GDP (trillions of 1992 dollars)

14. Two Time Frames for Aggregate Supply
We distinguish two time frames for aggregate supply:
Long-run aggregate supply
Short-run aggregate supply

15. Aggregate Supply Long-Run Aggregate Supply
Potential GDP is independent of the price level because the price level, wage rate, and other resource prices all change by the same percentage in the “long-run”.

16. Aggregate Supply Short-Run Aggregate Supply
The macroeconomic short run is a period during which real GDP has fallen below or risen above potential GDP.
The unemployment rate has risen above or fallen below the natural rate.

17. Aggregate Supply Short-Run Aggregate Supply
The short-run aggregate supply curve is the relationship between the quantity of real GDP supplied and the price level in the short run when the money wage rate, other resource prices, and potential GDP remain constant.

18. Short-Run Aggregate Supply
Price Level Real GDP
(GDP deflator) (trillions of 1992 dollars) a b c d e

19. Short-Run Aggregate Supply
LAS
140
130
120
Price level (GDP deflator, 1992 = 100)
110
100 90
6.0
6.5
7.0
7.5
8.0
8.5
Real GDP (trillions of 1992 dollars)

20. Short-Run Aggregate Supply
LAS
140
130
SAS
120 e
Price level (GDP deflator, 1992 = 100) d
110 c b
100
Instructor Notes:
1) The short-run aggregate supply (SAS) curve shows the relationship between the quantity of real GDP supplied and the price level when the money wage rate, other resource prices, and potential GDP are constant.
2) The short-run aggregate supply curve SAS is based on the schedule in the table.
3) The short-run aggregate supply curve is upward-sloping because firms’ costs increase as the rate of output increases, so a higher price is needed, relative to the prices of productive resources, and bring forth an increase in the quantity produced.
4) On the SAS curve, when the price level is 110, real GDP equals potential GDP.
5) If the price level is greater than 110, real GDP exceeds potential GDP; if the price level is below 110, real GDP is less than potential GDP. a 90
6.0
6.5
7.0
7.5
8.0
8.5
Real GDP (trillions of 1992 dollars)

21. Short-Run Aggregate Supply
LAS
140
130
SAS
120 e
Price level (GDP deflator, 1992 = 100) d
110 c b
100
Instructor Notes:
If the price level is greater than 110, real GDP exceeds potential GDP; if the price level is below 110, real GDP is less than potential GDP. a
Real GDP below
potential GDP
Real GDP above
potential GDP 90
6.0
6.5
7.0
7.5
8.0
8.5
Real GDP (trillions of 1992 dollars)

22. Aggregate Supply Movements Along the LAS and SAS Curves
When the price level rises, holding the money wage rate and other resource prices constant, the quantity of real GDP supplied increases and there is a movement along the SAS curve.

23. Movements Along The Aggregate Supply Curves
LAS
140
130
SAS
120
Price level (GDP deflator, 1992 = 100)
110
100 90
6.0
7.0
8.0
Real GDP (trillions of 1992 dollars)

24. Movements Along The Aggregate Supply Curves
LAS
140
130
SAS
120
Price level (GDP deflator, 1992 = 100)
110
100
Instructor Notes:
1) A rise in the price level with no change in the money wage rate and other resource prices brings an increase in the quantity of real GDP supplied and a movement along the short-run aggregate supply curve.
2) A rise in the price level with equal percentage rises in the money wage rate and other resource prices keeps the quantity of real GDP supplied constant and brings a movement along the long-run aggregate supply curve. 90
6.0
7.0
8.0
Real GDP (trillions of 1992 dollars)

25. Movements Along The Aggregate Supply Curves
LAS
Price level rises and
money wage rate rises
by the same percentage
140
130
SAS
120
Price level (GDP deflator, 1992 = 100)
110
100
Price level rises and
money wage rate is
unchanged
Instructor Notes:
1) A rise in the price level with no change in the money wage rate and other resource prices brings an increase in the quantity of real GDP supplied and a movement along the short-run aggregate supply curve.
2) A rise in the price level with equal percentage rises in the money wage rate and other resource prices keeps the quantity of real GDP supplied constant and brings a movement along the long-run aggregate supply curve. 90
6.0
7.0
8.0
Real GDP (trillions of 1992 dollars)

26. Aggregate Supply Changes in Aggregate Supply
Occurs when influences on production other than the price level change

27. Aggregate Supply Potential GDP changes as a result of:
1) Changes in the full-employment quantity of labor
2) Changes in the quantity of capital
3) Advances in technology

28. A Change in Potential GDP
LAS
140
130
SAS0
120
Price level (GDP deflator, 1992 = 100)
110
100 90
6.0
7.0
8.0
Real GDP (trillions of 1992 dollars)

29. A Change in Potential GDP
LAS0
LAS1
140
Increase in
potential GDP
130
SAS0
120
SAS1
Price level (GDP deflator, 1992 = 100)
110
100
Instructor Notes:
An increase in potential GDP increases both long-run aggregate supply and short-run aggregate supply and shifts both aggregate supply curves rightward, from LAS0 to LAS1 and from SAS0 to SAS1 . 90
6.0
7.0
8.0
Real GDP (trillions of 1992 dollars)

30. Aggregate Supply
Changes in the money wage rate changes short-run aggregate supply but does not change long-run aggregate supply.

31. A Change in the Money Wage Rate
LAS
140
130
SAS0
120
Price level (GDP deflator, 1992 = 100)
110 a
100 90
6.0
7.0
8.0
Real GDP (trillions of 1992 dollars)

32. A Change in the Money Wage Rate
LAS
140
SAS2
130
SAS0
120 b
Price level (GDP deflator, 1992 = 100)
110 a
100
Instructor Notes:
1) A rise in the money wage rate decreases short-run aggregate supply and shifts the short-run aggregate supply curve leftward from SAS0 to SAS2.
2) A rise in the money wage rate does not change potential GDP, so the long-run aggregate supply curve does not shift. 90
6.0
7.0
8.0
Real GDP (trillions of 1992 dollars)

33. Aggregate Demand Y = C + I + G + X – M
The quantity of real GDP demanded is the sum of the real consumption expenditure (C), investment (I), government purchases (G), and exports (X) minus imports (M).
Y = C + I + G + X – M

34. Aggregate Demand
Aggregate demand is the relationship between the quantity of real GDP demanded and the general price level.
Important: The aggregate demand schedule is not a relationship based upon the relative prices of goods such as apples and pears.

35. Aggregate Demand a' 90 8.0 b' 100 7.5 c' 110 7.0 d' 120 6.5 e' 130 6.0
Price Level Real GDP
(GDP deflator) (trillions of 1992 dollars) a' b' c' d' e'

36. Aggregate Demand
140
130
120
Price level (GDP deflator, 1992 = 100)
110
100
Instructor Notes:
The aggregate demand curve (AD) shows the relationship between the quantity of real GDP demanded and the price level. 90
6.0
6.5
7.0
7.5
8.0
Real GDP (trillions of 1992 dollars)

37. Aggregate Demand 140 e' 130 d' 120 c' 110 b' 100 e' 90 AD 6.0 6.5 7.0
Price level (GDP deflator, 1992 = 100) c'
110 b'
100
Instructor Notes:
1) The aggregate demand curve (AD) shows the relationship between the quantity of real GDP demanded and the price level.
2) The aggregate demand curve is based on the schedule in the table.
3) Each point a’ through e’ on the curve corresponds to the row in the table identified by the same letter.
4) Thus when the price level is 110, the quantity of real GDP demanded is $7.0 trillion, shown by point c’ in the figure. e' 90 AD
6.0
6.5
7.0
7.5
8.0
Real GDP (trillions of 1992 dollars)

38. Aggregate Demand 140 e' 130 d' 120 c' 110 b' 100 e' 90 AD 6.0 6.5 7.0
Price level (GDP deflator, 1992 = 100) c'
110 b'
100
Instructor Notes:
1) The aggregate demand curve (AD) shows the relationship between the quantity of real GDP demanded and the price level.
2) The aggregate demand curve is based on the schedule in the table.
3) Each point a’ through e’ on the curve corresponds to the row in the table identified by the same letter.
4) Thus when the price level is 110, the quantity of real GDP demanded is $7.0 trillion, shown by point c’ in the figure. e' 90 AD
6.0
6.5
7.0
7.5
8.0
Real GDP (trillions of 1992 dollars)

39. Aggregate Demand The two reasons the demand curve sloped downward are:
1) Wealth effect
Changes in the price level, with other things remaining the same, change real wealth.
People try to restore wealth by increasing saving and decreasing consumption.

40. Aggregate Demand The two reasons the demand curve sloped downward are:
2) Substitution effects
People substitute future consumption for present consumption as a result of higher interest rates.
A change in prices cause consumers to spend less on domestic items and more on imported items.

41. Aggregate Demand Changes in the Quantity of Real GDP Demanded
When the price level changes, other things remaining the same, the quantity of real GDP demanded changes and there is movement along the aggregate demand curve.

42. Aggregate Demand Changes in Aggregate Demand
A change in any factor than influences buying plans other than the price level

43. Aggregate Demand
The factors that influence buying plans other than the price level and bring a change in aggregate demand are:
1) Expectations
2) Fiscal policy and monetary policy
3) The world economy

44. Aggregate Demand Expectations
Expectations about future incomes, inflation and profits influence buying plans today.

45. Aggregate Demand Fiscal Policy and Monetary Policy
Fiscal policy is the government’s attempt to influence the economy by setting and changing taxes, transfer payments, and government purchases.

46. Aggregate Demand Fiscal Policy and Monetary Policy
These influence a household’s disposable income.
Disposable income equals aggregate income minus taxes plus transfer payments.

47. Aggregate Demand Fiscal Policy and Monetary Policy
Monetary policy consists of changes in interest rates and in the quantity of money in the economy.

48. Aggregate Demand The World Economy
The exchange rate and foreign income affect aggregate demand.

49. Changes in Aggregate Demand
140
130
120
Price level (GDP deflator, 1992 = 100)
110
100 90
AD0
6.0
6.5
7.0
7.5
8.0
Real GDP (trillions of 1992 dollars)

50. Changes in Aggregate Demand
140
Increase in
aggregate
demand
130
120
Price level (GDP deflator, 1992 = 100)
110
100
AD1 90
AD0
6.0
6.5
7.0
7.5
8.0
Real GDP (trillions of 1992 dollars)

51. Changes in Aggregate Demand
140
Increase in
aggregate
demand
130
120
Price level (GDP deflator, 1992 = 100)
110
100
AD1
Decrease in
aggregate
demand 90
AD2
AD0
6.0
6.5
7.0
7.5
8.0
Real GDP (trillions of 1992 dollars)

52. Changes in Aggregate Demand
Decreases if:
Increases if:
Expected future incomes, inflation, or profits decrease
Fiscal policy decreases government purchases, increases taxes, or decreases transfer payments
Expected future incomes, inflation, or profits increase
Fiscal policy increases government purchases, decreases taxes, or increases transfer payments

53. Changes in Aggregate Demand
Decreases if:
Increases if:
Monetary policy decreases the quantity of money and increases interest rates
The exchange rate increases or foreign income decreases
Monetary policy increases the quantity of money and decreases interest rates
The exchange rate decreases or foreign income increases

54. Macroeconomic Equilibrium
Short-Run Macroeconomic Equilibrium
Occurs when the quantity of real GDP demanded equals the quantity of real GDP supplied

55. Short-Run Equilibrium
140
130
120
Price level (GDP deflator, 1992 = 100)
110
100 90
6.0
6.5
7.0
7.5
8.0
Real GDP (trillions of 1992 dollars)

56. Short-Run Equilibrium
140
130
SAS
120 e
Price level (GDP deflator, 1992 = 100) d
110 c b
100 a
Instructor Notes:
Short-run macroeconomic equilibrium occurs when real GDP demanded equals real GDP supplied--at the intersection of the aggregate demand curve (AD) and the short-run aggregate supply curve (SAS). 90 AD
6.0
6.5
7.0
7.5
8.0
Real GDP (trillions of 1992 dollars)

57. Short-Run Equilibrium
140 e'
130
SAS d'
120 e
Price level (GDP deflator, 1992 = 100) c' d
110 c b' b
100 a
Instructor Notes:
Here, such an equilibrium occurs at points c and c’, where the price level is 110 and real GDP is $7 trillion. e' 90 AD
6.0
6.5
7.0
7.5
8.0
Real GDP (trillions of 1992 dollars)

58. Short-Run Equilibrium
140
Firms cut
production
and prices e'
130
SAS d'
120 e
Price level (GDP deflator, 1992 = 100) c' d
110 c b' b
100 a
1) If the price level is 120 and real GDP is $8 trillion (point e), firms will not be able to sell all their output.
2) They will decrease production and cut prices. e' 90 AD
6.0
6.5
7.0
7.5
8.0
Real GDP (trillions of 1992 dollars)

59. Short-Run Equilibrium
140
Firms cut
production
and prices e'
130
SAS d'
120 e
Price level (GDP deflator, 1992 = 100) c' c' d
110 c b' b
100 a
1) If the price level is 100 and real GDP is $6 trillion (point a), people will not be able to buy all the goods and services they demand.
2) Firms will increase production and raise their prices. e'
Firms increase
production
and prices 90 AD
6.0
6.5
7.0
7.5
8.0
Real GDP (trillions of 1992 dollars)

60. Short-Run Equilibrium
140 e'
130
SAS d'
120 e
Price level (GDP deflator, 1992 = 100) c' c' d
110
Short-run
macroeconomic
equilibrium c b' b
100 a
1) Only when the price level is 110 and real GDP is $7 trillion can firms sell all that they produce and people buy all that they demand.
2) This is the short-run macroeconomic equilibrium. e' 90 AD
6.0
6.5
7.0
7.5
8.0
Real GDP (trillions of 1992 dollars)

61. Macroeconomic Equilibrium
Long-Run Macroeconomic Equilibrium
Occurs when real GDP equals potential GDP, (i.e. the economy is on its long-run aggregate supply curve)

62. Long-Run Equilibrium
140
130
120
Price level (GDP deflator, 1992 = 100)
110
100 90
6.0
6.5
7.0
7.5
8.0
Real GDP (trillions of 1992 dollars)

63. Long-Run Equilibrium 140 130 SAS 120 110 100 90 6.0 6.5 7.0 7.5 8.0
Price level (GDP deflator, 1992 = 100)
110
In the long run,
money wage
adjusts
100 90
6.0
6.5
7.0
7.5
8.0
Real GDP (trillions of 1992 dollars)

64. Long-Run Equilibrium 140 130 SAS 120 110 100 90 AD 6.0 6.5 7.0 7.5 8.0
Price level (GDP deflator, 1992 = 100)
110
In the long run,
money wage
adjusts
100 90 AD
6.0
6.5
7.0
7.5
8.0
Real GDP (trillions of 1992 dollars)

65. Long-Run Equilibrium LAS 140 130 SAS 120 110 100 90 AD 6.0 6.5 7.0 7.5
Price level (GDP deflator, 1992 = 100)
110
In the long run,
money wage
adjusts
100
Instructor Notes:
1) In long-run macroeconomic equilibrium, real GDP equals potential GDP.
2) So long-run equilibrium occurs where the aggregate demand curve intersects the long-run aggregate demand curve.
3) In the long run, aggregate demand determines the price level and has no effect on real GDP.
4) The money wage rate adjusts in the long run so that the SAS curve intersects the LAS curve at the long-run equilibrium price level. 90 AD
6.0
6.5
7.0
7.5
8.0
Real GDP (trillions of 1992 dollars)

66. Macroeconomic Equilibrium
In the long run, the main influence on aggregate demand is the growth rate of the quantity of money.
Real GDP fluctuates around potential GDP in a business cycle.
Inflation fluctuates at the same time.

67. Macroeconomic Equilibrium
Business Cycles
Occur because aggregate demand and short-run aggregate supply fluctuate but the money wage rate does not adjust quickly enough to keep real GDP at potential GDP.

68. Macroeconomic Equilibrium
Below Full-employment Equilibrium
A macroeconomic equilibrium in which potential GDP exceeds real GDP
The difference is called a recessionary gap.

69. Macroeconomic Equilibrium
Long-Run Equilibrium
Occurs when real GDP equals potential GDP.

70. Macroeconomic Equilibrium
Above Full-employment Equilibrium
A macroeconomic equilibrium in which real GDP exceeds potential GDP
The difference is called a inflationary gap.

71. The Business Cycle LAS 140 130 SAS0 120 a 110 100 90 AD0 6.8 7.0 7.2
Recessionary
gap
SAS0
120
Price level (GDP deflator, 1992 = 100) a
Below full-employment
equilibrium
110
100
Instructor Notes:
1)The graph shows a below full-employment equilibrium in year 1.
2) There is a recessionary gap and the economy is at point a. 90
AD0
6.8
7.0
7.2
Real GDP (trillions of 1992 dollars)

72. The Business Cycle 7.2 7.0 6.8 1 2 3 4 Fluctuations in real GDP Year
Real GDP (trillions of 1992 dollars)
7.0
Instructor Notes:
The graph shows how real GDP fluctuates around potential GDP in a business cycle.
6.8 1 2 3 4
Year

73. The Business Cycle 7.2 7.0 6.8 1 2 3 4 Fluctuations in real GDP Year
Potential
GDP
Real GDP (trillions of 1992 dollars)
7.0
Instructor Notes:
The graph shows how real GDP fluctuates around potential GDP in a business cycle.
6.8 1 2 3 4
Year

74. The Business Cycle 7.2 7.0 6.8 a 1 2 3 4 Fluctuations in real GDP Year
Recesssionary
gap
Potential
GDP
Real GDP (trillions of 1992 dollars)
7.0
Instructor Notes:
The graph shows how real GDP fluctuates around potential GDP in a business cycle.
Actual
GDP
6.8 a 1 2 3 4
Year

75. The Business Cycle LAS 140 130 SAS1 120 110 b 100 90 AD1 6.8 7.0 7.2
Full
employment
130
SAS1
120
Price level (GDP deflator, 1992 = 100)
110 b
Long-run
equilibrium
100
Instructor Notes:
1) The graph shows a long-run equilibrium in year 2.
2) There is a long-run equilibrium and the economy is at point b. 90
AD1
6.8
7.0
7.2
Real GDP (trillions of 1992 dollars)

76. The Business Cycle 7.2 7.0 6.8 a 1 2 3 4 Fluctuations in real GDP Year
Recesssionary
gap
Potential
GDP
Real GDP (trillions of 1992 dollars)
7.0
Instructor Notes:
The graph shows how real GDP fluctuates around potential GDP in a business cycle.
Actual
GDP
6.8 a 1 2 3 4
Year

77. The Business Cycle 7.2 7.0 b 6.8 a 1 2 3 4 Fluctuations in real GDP
Recesssionary
gap
Full
employment
Potential
GDP
Real GDP (trillions of 1992 dollars)
7.0 b
Instructor Notes:
The graph shows how real GDP fluctuates around potential GDP in a business cycle.
Actual
GDP
6.8 a 1 2 3 4
Year

78. The Business Cycle LAS 140 130 SAS2 120 110 c 100 AD2 90 7.0 7.2
Inflationary
gap
Price level (GDP deflator, 1992 = 100)
Above full-employment
equilibrium
110 c
100
Instructor Notes:
1) The graph shows an above full-employment equilibrium in year 3.
2) There is an inflationary gap and the economy is at point c.
AD2 90
7.0
7.2
Real GDP (trillions of 1992 dollars)

79. The Business Cycle 7.2 7.0 b 6.8 a 1 2 3 4 Fluctuations in real GDP
Recesssionary
gap
Full
employment
Potential
GDP
Potential
GDP
Real GDP (trillions of 1992 dollars)
7.0 b
Instructor Notes:
The graph shows how real GDP fluctuates around potential GDP in a business cycle.
Actual
GDP
6.8 a 1 2 3 4
Year

80. The Business Cycle c 7.2 7.0 b 6.8 a 1 2 3 4 Fluctuations in real GDP
Recesssionary
gap
Full
employment
Potential
GDP
Real GDP (trillions of 1992 dollars)
7.0 b
Inflationary
gap
Instructor Notes:
The graph shows how real GDP fluctuates around potential GDP in a business cycle.
Actual
GDP
6.8 a 1 2 3 4
Year

81. Macroeconomic Equilibrium
Fluctuations is Aggregate Demand
Real GDP sometimes fluctuates as a result of changes in aggregate demand.

82. An Increase in Aggregate Demand
LAS
140
Short-run
effect
130
SAS0
Price level (GDP deflator, 1992 = 100)
115
110
100 90
AD0
6.0
7.0
7.5
Real GDP (trillions of 1992 dollars)

83. An Increase in Aggregate Demand
LAS
140
Short-run
effect
130
SAS0
Price level (GDP deflator, 1992 = 100)
115
110
100
Instructor Notes:
1) An increase in aggregate demand shifts the aggregate demand curve from AD0 to AD1.
2) In the short-run equilibrium, real GDP is $7.5 trillion and the price level rises to 115.
3) In this situation, there is an inflationary gap.
AD1 90
AD0
6.0
7.0
7.5
Real GDP (trillions of 1992 dollars)

84. An Increase in Aggregate Demand
LAS
140
Long-run
effect
130
SAS0
Price level (GDP deflator, 1992 = 100)
115
100
AD1 90
6.0
7.0
7.5
Real GDP (trillions of 1992 dollars)

85. An Increase in Aggregate Demand
LAS
140
SAS1
Long-run
effect
130
125
SAS0
Price level (GDP deflator, 1992 = 100)
115
100
Instructor Notes:
1) The money wage rate rises, and the short-run aggregate supply curve shifts leftward from SAS0 to SAS1.
2) As it shifts, it intersects the aggregate demand curve AD1at higher price levels and lower real GDP levels.
3) Eventually, the price level rises to 125 and real GDP decreases to $7.0 trillion--potential GDP.
AD1 90
6.0
7.0
7.5
Real GDP (trillions of 1992 dollars)

86. Macroeconomic Equilibrium
An economy cannot produce in excess of potential forever.
Workers begin to demand higher wages
Eventually, wage rates rise by the same percentage as the price level.

87. Macroeconomic Equilibrium
Fluctuations in Aggregate Supply
Fluctuations in short-run aggregate supply can bring fluctuations in real GDP around potential GDP.
A decrease in aggregate supply can lead to a recession and inflation — stagflation.

88. A Decrease in Aggregate Supply
LAS
140
130
SAS0
120
Price level (GDP deflator, 1992 = 100)
110
100 90
AD0
6.0
6.5
7.0
7.5
8.0
8.5
Real GDP (trillions of 1992 dollars)

89. A Decrease in Aggregate Supply
LAS
An oil price rise
decreases short-run
aggregate supply
140
SAS1
130
SAS0
120
Price level (GDP deflator, 1992 = 100)
110
100
Instructor Notes:
1) An increase in the price of oil decreases short-run aggregate supply and shifts the short-run aggregate supply curve from SAS0 to SAS1 .
2) Real GDP decreases from $7.0 trillion to $6.5 trillion, and the price level rises from 110 to 120.
3) The economy experiences both recession and inflation--stagflation. 90
AD0
6.0
6.5
7.0
7.5
8.0
8.5
Real GDP (trillions of 1992 dollars)

90. Aggregate Supply and Aggregate Demand: 1960–1996