Aggregate Demand and Supply

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Aggregate Demand and Supply Chapter 22 Aggregate Demand and Supply

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.

Why the Aggregate Demand Curve Slopes Downward (2) Copyright © Houghton Mifflin Company. All rights reserved.

The Interest Rate Effect Copyright © Houghton Mifflin Company. All rights reserved.

Why the Aggregate Demand Curve Slopes Downward (4) Copyright © Houghton Mifflin Company. All rights reserved.

The Aggregate Demand Curve Note that changes in prices result in changes in the aggregate quantity demanded. 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.

Non-price Determinants: Changes in Aggregate Demand (1) Copyright © Houghton Mifflin Company. All rights reserved.

Nonprice Determinants: Changes in Aggregate Demand (2) Copyright © Houghton Mifflin Company. All rights reserved.

Non-price Determinants: Changes in Aggregate Demand (3) Copyright © Houghton Mifflin Company. All rights reserved.

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

Effects of a Change in Aggregate Demand Demand-pull inflation: rapid increases in AD outpace the growth of AS, causing price level increases (inflation). Copyright © Houghton Mifflin Company. All rights reserved.

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.

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

Shape of Short-run AS (SRAS) In the short-run, the capital stock (the number of factories and machines, etc.) are held constant. Increasing the number of workers increases output, but at a diminishing rate. Diminishing returns manifest as an ever-steeper SRAS curve. In the short-run, some prices do not adjust quickly: Labor Costs (wages) Contracted supplies “Sticky” prices effect the short-run equillibrium Copyright © Houghton Mifflin Company. All rights reserved.

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

The Shape of Long-run AS (LRAS) Resource costs are NOT fixed. As prices rise, workers will want higher wages and will eventually get them. The amount of capital is not fixed—firms can build new plants and buy new equipment over the long-run. In the long-run, AS is set by the production possibilities curve—the capacity of the economy, and is not affected by prices, hence is vertical. Copyright © Houghton Mifflin Company. All rights reserved.

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

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

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

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

Shifting the Long-Run Aggregate Supply Curve Growth occurs as the labor force and the capital stock grow, as technological innovation improves production efficiency. Copyright © Houghton Mifflin Company. All rights reserved.

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

Effects of a Change in Aggregate Supply Cost-push inflation: cost increases push AS to the left (relative to AD), causing price level increases (inflation). Copyright © Houghton Mifflin Company. All rights reserved.

Aggregate Demand and Aggregate Supply Equilibrium Copyright © Houghton Mifflin Company. All rights reserved.

Aggregate Demand and Supply Equilibrium Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved.

Copyright © Houghton Mifflin Company. All rights reserved.

Economic Insight: OPEC and Aggregate Supply Copyright © Houghton Mifflin Company. All rights reserved.