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Aggregate demand and supply
The document summarizes the aggregate supply (AS) and aggregate demand (AD) model. It defines AS and AD as relationships between price levels and real GDP. The intersection of the AS and AD curves determines equilibrium output and price levels. The document outlines the components of aggregate demand as consumption, investment, government spending, and net exports. It also discusses factors that can cause shifts in the AS and AD curves, such as income, wealth, interest rates, and exchange rates.
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Aggregate demand and supply
- 2.
- 3. The AS/AD modelis the basic macroeconomic tool for studying output fluctuations and the determination of the price level and the inflation rate ◦ Can be used to explain how the economy deviates from a path of smooth growth over time, and to explore the consequences of government policies intended to reduce unemployment and output fluctuations, and maintain stable prices
- 4. Aggregate demand– a relationship between the price level and the equilibrium quantity of real GDP demanded. Aggregate supply – a relationship between the price level and the equilibrium quantity of real GDP supplied. Intersection of AS and AD curves determines the equilibrium level of output and price level
- 5. AS and ADintersect at point E in Figure Equilibrium: AS = AD Equilibrium output is Y0 Observed level of output in the economy at particular point in time Equilibrium price level is P0 Observed price level in the economy at particular point in time
- 6. The amount ofthe increase/decrease in P and Y after a shift in either aggregate supply or aggregate demand depends on: 1. The slope of the AS curve 2. The slope of the AD curve 3. The extent of the shift of AS/AD
- 7. Aggregate demand(AD) consists of spending on GDP by: ◦ consumers (C) ◦ firms (I) ◦ the government (G), and ◦ the foreign sector (NX) Anything that increases C, I, G, or NX at a given price level results in an increase in AD.
- 8. Income Wealth Expected future income and wealth Demographics Taxes
- 9. Interest rate Technology Cost of capital goods Capacity utilization
- 10. Determined by governmentauthorities
- 11. Foreign anddomestic income Foreign and domestic price levels Exchange rates Government policy (tariffs, trade restrictions, etc.)
- 12. AE =C+I+G+NX AE is affected by any factor that changes C, I, G, or NX.
- 13. Note thatAD curve is not the same as the demand curve for a particular good ◦ negative slope is NOT the result of income and substitution effects Why is it downward sloping? ◦ Wealth effect ◦ Interest rate ◦ International trade effect
- 14. As theprice level rises: ◦ the real value of dollar-denominated assets decline (real wealth declines) ◦ this decline in wealth results in a reduction in consumption spending This affect is also called the real-balance effect (or Pigou effect)
- 15. As theprice level rises: ◦ Individuals must hold more money to pay for transactions ◦ To acquire more money, households sell bonds, and other financial assets. ◦ As more bonds are sold, the price of bonds declines ◦ A decline in bond prices results in a higher rate of return (interest rate) on bonds and other financial assets ◦ A higher interest rate results in a reduction in investment and consumption spending
- 16. As thedomestic price level rises: ◦ Imports become relatively cheaper, ◦ Exports become relatively more expensive ◦ Exports decline, imports rise, and net exports decline
- 17. As the pricelevel rises, AE falls due to the combined wealth, interest-rate, and international trade effects
- 18. Anything thatchanges C, I, G, or NX at a given price level will cause the AD curve to shift Effects of: ◦ Expectations (consumer and investor confidence) ◦ Foreign income and price levels ◦ Government policy
- 19. Price-level effects ◦Assumption: Resource prices adjust more slowly than output prices ◦ As price level rises, production becomes more profitable and the quantity of output supplied rises.
- 22. Resource and outputprices are assumed to be flexible in the long run. Output = potential real GDP.
- 23. Resource prices Technology Expectations
- 24. Changes inthe quantity and/or quality of resources Technology