Aggregate Demand and Supply The aggregate-demand curve shows the quantity of goods and services that households, firms, and the government want to buy at each price level. The aggregate-supply curve shows the quantity of goods and services that firms choose to produce and sell at each price level.

Why the Aggregate Demand Curve Slopes Downward (1) Aggregate demand (AD) is the economy-wide demand for goods and services. Like the market demand curve, the aggregate demand curve slopes downward, but for different reasons. The reasons for its downward slope are price-level effects: Wealth Effect (Real Wealth/Real Balances) Interest Rate Effect International Trade Effect (Substitution) Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Pigou's Wealth Effect A drop in the price level induces consumers to spend more, thereby increasing the aggregate demand. Copyright © Houghton Mifflin Company. All rights reserved.

The Interest Rate Effect A drop in the price level decreases the interest rate, which increases the demand for investment and thereby increases aggregate demand. Copyright © Houghton Mifflin Company. All rights reserved.

Mundell-Fleming's Exchange-Rate Effect A lower price level in an economy reduces the prices of its goods and services relative to foreign-produced goods and services. A lower price level makes that economy’s goods more attractive to foreign buyers, increasing exports Copyright © Houghton Mifflin Company. All rights reserved.

Figure 3 The Aggregate-Demand Curve... Price Level Aggregate demand P Y 1. A decrease in the price level . . . Y2 P2 Quantity of 2. . . . increases the quantity of goods and services demanded. Output Copyright © 2004 South-Western

Components of the Aggregate Demand The four components of GDP (Y) contribute to the aggregate demand for goods and services. Y = C + I + G + NX

Copyright © Houghton Mifflin Company. All rights reserved. Factors that Affect AD AD = C + I + G + XN Consumption Income Wealth Expectations Demographics Taxes Investment Interest Rates Technology Cost of Capital Goods Capacity Utilization Government Spending Net Exports Domestic & Foreign Income Domestic & Foreign Prices Exchange Rates Government Policy Copyright © Houghton Mifflin Company. All rights reserved.

Shifting the Aggregate Demand Curve Copyright © Houghton Mifflin Company. All rights reserved.

Reasons for Shift In AD Shift arising from Changes in Consumption Shifts Arising from Changes in Investment Shifts Arising from Changes in Government Purchases Shifts Arising from Changes in Net Exports

Shifting the Aggregate Demand Curve Copyright © Houghton Mifflin Company. All rights reserved.

Aggregate Supply Aggregate supply is the total supply of all goods and services in the economy. The aggregate supply (AS) curve is a graph that shows the relationship between the aggregate quantity of output supplied by all firms in an economy and the overall price level.

Determinants of Aggregate Supply Resource prices Technology Expectation of future prices

Determinants of Aggregate Supply (1) Resource Prices Copyright © Houghton Mifflin Company. All rights reserved.

Determinants of Aggregate Supply (2) Technology Copyright © Houghton Mifflin Company. All rights reserved.

Determinants of Aggregate Supply (3) Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved. Aggregate Supply Copyright © Houghton Mifflin Company. All rights reserved.

Why Aggregate Supply curve slopes upward Sticky Wage theory Sticky Price Theory

Short-run Aggregate Supply Aggregate Supply (AS) is the total of all the firm (market) supply curves. It shows the quantity of real GDP produced at different price levels. Short-run AS slopes upward because an increase in the price level (while production costs and capital are held constant on the short-run), means higher profit margins—firms will want to produce more. Copyright © Houghton Mifflin Company. All rights reserved.

Changes in Short-Run Aggregate Supply Copyright © Houghton Mifflin Company. All rights reserved.

Factors that shift the Aggregate Supply Curve deregulation Bad weather, natural disasters, destruction b/ wars Good weather Public policy waste and inefficiency supply-side policies over-regulation tax cuts Capital deterioration more capital more labor higher input prices lower input prices higher wage rates lower wage rates Factors That Shift the Aggregate Supply Curve Shifts to the Left Decreases in Aggregate Supply Shifts to the Right Increases in Aggregate Supply technological change Stagnation Economic growth Higher costs Lower costs

The Shape of the Long-Run Aggregate Supply Curve Copyright © Houghton Mifflin Company. All rights reserved.

Shift in Long Run Aggregate supply LRAS LRAS Price Level Decrease Increase Real GDP

Shift in long run aggregate supply curve Changes in the supply of labor, due to immigration Changes in technological knowledge Changes in the stock of capital, physical or human Discoveries or depletion of stocks of natural resources Changes in natural rate of unemployment, due to changes in minimum wages

Macroeconomic Equilibrium An economy is at a state of equilibrium when the quantity of goods and services supplied in an economy equals the quantity of goods and service demanded in it. The price level where aggregate supply equals aggregate demand is called the equilibrium price. Short Run Equilibrium Long Run Equilibrium

Copyright © Houghton Mifflin Company. All rights reserved. Short Run Equilibrium Copyright © Houghton Mifflin Company. All rights reserved.

The Long-Run Equilibrium Price Level Long-run aggregate supply Short-run aggregate supply Aggregate demand A Equilibrium price Natural rate of output Quantity of Output Copyright © 2004 South-Western

Demand side Management