1. © 2008 Pearson Education Canada24.1 Chapter 24 Aggregate Demand and Supply Analysis

2. © 2008 Pearson Education Canada24.2 Aggregate Demand Aggregate Demand - The relationship between the quantity of aggregate output demanded and the price level when all other variables are held constant Based on the quantity theory of money –Determined solely by the quantity of money Based on the components parts –Consumption, investment, government spending and net exports

3. © 2008 Pearson Education Canada24.3 Quantity Theory of Money Approach to Aggregate Demand

4. © 2008 Pearson Education Canada24.4 Deriving the Aggregate Demand Curve Changes in the price level induce changes in the aggregate output demanded and hence movement along the AD curve (points A, B, and C in Figure 24-1) In the quantity theory, changes in the money supply are the primary source of changes in aggregate spending and thus shifts the AD curve.

5. © 2008 Pearson Education Canada24.5 Aggregate Demand Curve

6. © 2008 Pearson Education Canada24.6 Behavior of Aggregate Demand’s Component Parts

7. © 2008 Pearson Education Canada24.7 Factors that Shift Aggregate Demand An increase in the money supply shifts AD to the right because it lowers interest rates and stimulates investment spending An increase in spending from any of the components C, I, G, NX, will also shift AD to the right

8. © 2008 Pearson Education Canada24.8 Factors That Shift the Aggregate Demand Curve

9. © 2008 Pearson Education Canada24.9 Aggregate Supply Long-run aggregate supply curve (LRAS) –Determined by amount of capital and labor and the available technology –Vertical at the natural rate of output generated by the natural rate of unemployment

10. © 2008 Pearson Education Canada24.10 Short-run aggregate supply curve (SRAS) –Wages and prices are sticky –Generates an upward sloping SRAS as firms attempt to take advantage of short-run profitability when price level rises

11. © 2008 Pearson Education Canada24.11 Long Run Aggregate Supply

12. © 2008 Pearson Education Canada24.12 Short Run Aggregate Supply

13. © 2008 Pearson Education Canada24.13 Factors that Shift Short Run Aggregate Supply Costs of production –Tightness of the labor market –Expected price level –Wage push –Change in production costs unrelated to wages (supply shocks)

14. © 2008 Pearson Education Canada24.14 Factors that Shift Short Run Aggregate Supply (Cont’d)

15. © 2008 Pearson Education Canada24.15 Equilibrium of AS and AD in the Short Run

16. © 2008 Pearson Education Canada24.16 Equilibrium of AS and AD in the Long Run

17. © 2008 Pearson Education Canada24.17 Self-Correcting Mechanism Regardless of where output is initially, it returns eventually to the natural rate Slow –Wages are inflexible, particularly downward –Need for active government policy Rapid –Wages and prices are flexible –Less need for government intervention

18. © 2008 Pearson Education Canada24.18 Response of Output and the Price Level to a Shift in the AD Curve

19. © 2008 Pearson Education Canada24.19 Response of Output and the Price Level to a Shift in the AS Curve

20. © 2008 Pearson Education Canada24.20 Shifts in Long-Run Aggregate Supply Economic growth Real business cycle theory –Real supply shocks drive short-run fluctuations in the natural rate of output (shifts of LRAS) –No need for government intervention

21. © 2008 Pearson Education Canada24.21 Hysteresis –Departure from full employment levels as a result of past high unemployment –Natural rate of unemployment shifts upward and natural rate of output falls below full employment –Expansionary policy needed to shift aggregate demand

22. © 2008 Pearson Education Canada24.22Conclusions Shifts in aggregate demand affects output only in the short run and has no effect in the long run When shifts in aggregate demand occur, the initial change in the price level is less in the short run than it is in the long run when AS has fully adjusted

23. © 2008 Pearson Education Canada24.23 Shifts in short run aggregate supply affects output and price only in the short run and has no effect in the long run The economy has a self-correcting mechanism

24. © 2008 Pearson Education Canada24.24 Unemployment and Inflation in the United States 1964 -1970

25. © 2008 Pearson Education Canada24.25 Unemployment and Inflation in the United States 2000-2004