1. Chapter 19 Aggregate Demand and Supply
Interactive Examples
Aggregate Demand and Supply
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Material from this presentation can be found in:
Chapter 19
Slides Created By
Kevin Brady and Eric Chiang
CoreEconomics, 2e

2. Interactive Examples
Aggregate Demand and Supply
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Aggregate
Price Level
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The aggregate demand (AD) and aggregate supply (AS) model is used to analyze the economy.
It shows the relationship between aggregate output of goods and services in the economy and the price level.
Aggregate
Output
(Y)
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3. Question: Why is the AD curve negatively sloped?
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The AD curve shows the output of goods and services demanded at different price levels.
Question: Why is the AD curve negatively sloped? AD
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Output
(Y)
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Answer 3

4. Question: Why is the AD curve negatively sloped?
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The AD curve shows the output of goods and services demanded at different price levels.
Question: Why is the AD curve negatively sloped?
Answer: The three main reasons are the
1. wealth effect
2. export effect
3. interest rate effect AD
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Output
(Y)
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5. Question: What are the determinants of aggregate demand?
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The determinants of aggregate demand are those factors that shift the entire aggregate demand curve when they change.
Question: What are the determinants of aggregate demand? AD
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Output
(Y)
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Answer 5

6. Answer: They are the components of GDP. Consumer Spending Investment
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The determinants of aggregate demand are those factors that shift the entire aggregate demand curve when they change.
Question: What are the determinants of aggregate demand?
Answer: They are the components
of GDP.
Consumer Spending
Investment
Government Spending
Net Exports AD
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Output
(Y)
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7. Interactive Examples
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Question: If the stock market rises significantly during the next year, what would happen to the aggregate demand curve? AD
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(Y)
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Answer 7

8. Interactive Examples
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Question: If the stock market rises significantly during the next year, what would happen to the aggregate demand curve? P0
Answer: The aggregate demand curve would shift to the right. If the stock market rises, consumers will be wealthier, and they are willing to buy more at each price level.
AD1
Notice that at price level P0, aggregate output was Y0. After the increase in aggregate demand, aggregate output increases to Y1 at the price level P0.
AD0
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Output
(Y) Y0 Y1
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9. Interactive Examples
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Question: Assume the graph to the right represents the U.S. economy. If foreign countries become richer, will this affect aggregate demand in the U.S.? AD
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(Y)
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Answer 9

10. Interactive Examples
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Question: Assume the graph to the right represents the U.S. economy. If foreign countries become richer, will this affect aggregate demand in the U.S.?
Answer: Yes! The aggregate demand curve would shift to the right. If foreign consumers are richer, they will spend more. Part of this spending will be on U.S. exports.
AD1
AD0
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11. Interactive Examples
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Question: If the government decides to raise taxes in order to reduce the budget deficit, what would happen to the aggregate demand curve? AD
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(Y)
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Answer 11

12. Interactive Examples
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Question: If the government decides to raise taxes in order to reduce the budget deficit, what would happen to the aggregate demand curve?
Answer: The aggregate demand curve would shift to the left. Higher taxes will leave less money for consumers to spend at each price level.
AD0
AD1
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13. Interactive Examples
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The aggregate supply curve shows the real GDP that firms will produce at varying price levels.
We will need to make a distinction between the short-run aggregate supply curve (SRAS) and the long-run aggregate supply curve (LRAS).
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14. Let’s first begin with the SRAS curve.
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Let’s first begin with the SRAS curve.
SRAS
Question: Why is the SRAS curve positively sloped?
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Answer 14

15. Let’s first begin with the SRAS curve.
Interactive Examples
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Let’s first begin with the SRAS curve.
SRAS
Question: Why is the SRAS curve positively sloped?
Answer: The SRAS curve is positively sloped because some input costs are slow to change in the short run.
For example, when prices rise, wages for workers do not automatically adjust upward. The result is higher profits for businesses, which in turn induces them to supply more output.
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16. Question: What are the determinants of short-run aggregate supply?
Interactive Examples
Aggregate Demand and Supply
The determinants of the short-run aggregate supply curve are those factors that shift the entire aggregate supply curve when they change.
Aggregate
Price Level
(P)
SRAS
Question: What are the determinants of short-run aggregate supply?
Aggregate
Output
(Y)
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Answer 16

17. Productivity Taxes and Regulation Market Power of Firms Expectations
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The determinants of the short-run aggregate supply curve are those factors that shift the entire aggregate supply curve when they change.
Aggregate
Price Level
(P)
SRAS
Question: What are the determinants of short-run aggregate supply?
Answer: There are five main
determinants.
Input Prices
Productivity
Taxes and Regulation
Market Power of Firms
Expectations
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Output
(Y)
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18. Interactive Examples
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Question: If a new technology were developed that could extract twice the amount of energy from each barrel of oil, what would happen to the SRAS curve?
SRAS0
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(Y)
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Answer 18

19. Interactive Examples
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Question: If a new technology were developed that could extract twice the amount of energy from each barrel of oil, what would happen to the SRAS curve?
SRAS0
SRAS1
Answer: The SRAS curve would shift to the right. At each price level, suppliers would be willing to bring more goods to the market. P0
Notice that at price level P0, aggregate output was Y0. After the increase in aggregate supply, aggregate output increases to Y1 at the price level P0.
Aggregate
Output
(Y) Y0 Y1
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20. Interactive Examples
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Question: If businesses expect the prices for their products to rise in the near future, what would happen to the SRAS curve?
SRAS0
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(Y)
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Answer 20

21. Interactive Examples
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Question: If businesses expect the prices for their products to rise in the near future, what would happen to the SRAS curve?
SRAS1
SRAS0
Answer: The SRAS curve would shift to the left. If companies think they can sell their products for more money in the near future, they will cut back on their current supply and wait to get better prices.
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22. Interactive Examples
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Question: If the President of the United States enacts tough new compliance laws for every company importing goods in order to minimize the risk of terrorist activity, would this affect the aggregate supply curve?
SRAS0
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(Y)
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Answer 22

23. Interactive Examples
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Question: If the President of the United States enacts tough new compliance laws for every company importing goods in order to minimize the risk of terrorist activity, would this effect the aggregate supply curve?
SRAS1
SRAS0
Answer: Yes, the SRAS curve would shift to the left. The new compliance laws will raise the costs of supplying goods, and therefore producers will bring less product to market for each given price level.
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24. Let’s introduce the long-run aggregate supply curve (LRAS).
Interactive Examples
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Let’s introduce the long-run aggregate supply curve (LRAS).
Question: What is the time period cutoff between the short run and the long run?
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Answer 24

25. Let’s introduce the long-run aggregate supply curve (LRAS).
Interactive Examples
Aggregate Demand and Supply
Next
Aggregate
Price Level
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Let’s introduce the long-run aggregate supply curve (LRAS).
Question: What is the time period cutoff between the short run and the long run?
Answer: Trick question! In the current context, the difference between the short run and the long run has nothing to do with a time horizon. The difference is that in the short run prices are sticky and in the long run prices are flexible.
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26. Question: Why is the LRAS curve a vertical line?
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Question: Why is the LRAS curve a vertical line?
LRAS
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Answer 26

27. Question: Why is the LRAS curve a vertical line?
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Question: Why is the LRAS curve a vertical line?
LRAS
Answer: The LRAS is vertical at full employment because the economy has reached its maximum capacity to produce.
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28. Question: What are the determinants of the LRAS curve?
Interactive Examples
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The determinants of the long-run aggregate supply curve are those factors that shift the entire LRAS curve when they change.
LRAS
Question: What are the determinants of the LRAS curve?
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Output
(Y)
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Answer 28

29. Question: What are the determinants of the LRAS curve?
Interactive Examples
Aggregate Demand and Supply
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Aggregate
Price Level
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The determinants of the long-run aggregate supply curve are those factors that shift the entire LRAS curve when they change.
LRAS
Question: What are the determinants of the LRAS curve?
Answer: The determinants of the LRAS curve are
resources
productivity
technology
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30. Interactive Examples
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Question: If the largest earthquake ever recorded struck the economy and made it impossible to extract certain vital natural resources, what would happen to the LRAS curve?
LRAS
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(Y)
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Answer 30

31. Interactive Examples
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Question: If the largest earthquake ever recorded struck the economy and made it impossible to extract certain vital natural resources, what would happen to the LRAS curve?
LRAS1
LRAS0
Answer: The LRAS curve would shift to the left because the productive capacity of the economy would be smaller.
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32. Interactive Examples
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Question: What effect did the invention of the internet have on the LRAS curve?
LRAS
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Answer 32

33. Interactive Examples
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Question: What effect did the invention of the internet have on the LRAS curve?
LRAS0
LRAS1
Answer: The LRAS curve shifted to the right as a result of the invention of the internet. The new technology made workers more productive and opened the door to new industries, both of which increased the productive capacity of the economy.
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34. We are now ready to discuss the concept of macroeconomic equilibrium.
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We are now ready to discuss the concept of macroeconomic equilibrium.
LRAS
SRAS
Short-run macroeconomic equilibrium occurs at the intersection of the SRAS and AD curves.
Long-run macroeconomic equilibrium occurs at the intersection of the SRAS, AD, and LRAS curves. AD
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35. Interactive Examples
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Assume the economy is in long-run macroeconomic equilibrium at price level P0 and output level Y0.
LRAS0
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Question: If home prices across the economy rise, what will be the short-run and long-run effects in our model? P0
AD0
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Output
(Y) Y0
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Answer 35

36. Interactive Examples
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Question: If home prices across the economy rise, what will be the short-run and long-run effects in our model?
SRAS1
LRAS0
SRAS0 P2
Answer: An increase in home values increases wealth. In the short run, this causes the AD0 curve to shift to the right to AD1. Note that the price level and output level have increased to P1 and Y1, respectively. P1 P0
AD1
Answer: In the long run, workers will feel the pressure of the increased prices and demand higher wages. This will cause the SRAS0 curve to shift to the left to SRAS1. Here a new equilibrium is reached at P2 and Y0.
AD0
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(Y) Y0 Y1
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