ECO 102 Macroeconomics Chapter 3 Aggregate Demand and Aggregate Supply Prof. Dr. Magdy El-Shourbagui Head of the Department of Economics College of Business & Economics Misr University for Science & Technology www.magdyel-shourbagui.com

Learning Objectives Define the following terms: aggregate demand, aggregate supply, economy’s potential real GDP, and macroeconomic equilibrium. Distinguish between the aggregate demand curve and the aggregate supply curve. Identify and describe the reasons for downward slope of the aggregate demand curve. Identify and describe the factors that shift the aggregate demand curve. Explain and illustrate graphically the macroeconomic equilibrium in the short run

Real GDP = Y = AD = C + I + G + NX The Meaning of Aggregate Demand Aggregate Demand, AD is the quantity demanded of all final goods and services (Real GDP) at different price levels. AD can be calculated by the following equation: Real GDP = Y = AD = C + I + G + NX = C + I + G + (X -M) Where: C = personal consumption spending, I = gross private domestic spending, G = government spending, NX = net exports of goods and services, X = exports of goods and services, and M = imports of goods and services.

The Aggregate Demand Curve The Aggregate demand, AD curve is downward-sloping, specifying a negative relationship between the price level as independent variable and the quantity of real GDP demanded as dependent variable.

The price level and investment (The interest rate effect), and Reasons for Downward slope of the Aggregate Demand Curve The price level and consumption (The Real wealth effect or the real money balance effect), The price level and investment (The interest rate effect), and The price level and net exports (The international trade effect).

1. The price level and consumption (The Real wealth effect or the real money balance effect), Real Wealth is the value of money in bank, bonds, stocks, and non-monetary assets people own measured in terms of what they will buy. the real purchasing power of money balances (currency and bank deposits) and the real, monetary wealth The price level real wealth. consumers feel wealthier encourages them to spend more quantity demanded of Real GDP quantity of goods and services demanded

2. The Price Level and Investment (The Interest Rate Effect) money needed to buy fixed bundle of goods and services the purchasing power of money the domestic saving the interest rate supply of credit the banks will provide more loans spending on investment goods by households and businesses

the domestic goods will be cheaper relative to foreign goods 3. The Price Level and Net Exports (The International Trade Effect) the domestic goods will be cheaper relative to foreign goods Exports (X) and Imports (M) Net Exports (NX)

A Change in the Quantity Demanded of the Real GDP: A Movement along the Aggregate Demand Curve A change in the quantity demanded of real GDP caused by a change in the price level. It is shown by a movement along the aggregate demand curve

A Change in Aggregate Demand: Shifts in the Aggregate Demand Curve A Change in aggregate demand is the change in the quantity demanded of real GDP as the change in the following factors: Consumption, investment, government spending, and net exports. These factors will affect the quantity demanded of real GDP at any given price level. The aggregate demand curve shifts, when one of the factors above changes.

An Increase in Aggregate Demand An increase in aggregate demand is represented by an outward shift of the entire aggregate demand curve. If aggregate demand increases, greater quantities of real GDP are demanded at each possible price level for the year.

A Decrease in Aggregate Demand A decrease in aggregate demand is represented by an inward shift of the entire aggregate demand curve. When aggregate demand decreases, a less quantity of real GDP is demanded at each possible price level for the year.

Factors that shift the Aggregate Demand Curve The aggregate demand curve will shift as a result of changes in the following: Consumption Spending (C); Investment Spending (I); Government Spending (G); and Net Exports (NX). The AD curve shifts to the right side when aggregate demand increases. However, the AD curve shifts to the left side when aggregate demand decreases.

aggregate demand curve Factors that shift the Aggregate Demand Curve 1. Consumption Spending (C) The following factors can cause consumption spending to change: a) Consumer Wealth; b) Personal Income Taxes; and c) Expectations about Future Income, and Inflation. a) Consumer Wealth Consumer Wealth demand for goods and services by consumers consumers feel wealthier Consumption Spending ( C ) rightward shift of the aggregate demand curve aggregate demand

aggregate demand curve Factors that shift the Aggregate Demand Curve b) Personal Income Taxes personal income tax disposable income of households Consumption Spending ( C ) rightward shift of the aggregate demand curve aggregate demand

Factors that shift the Aggregate Demand Curve c) Expectations about Future Income, and Inflation the amount of consumption goods that people plan to buy today expected future income rightward shift of the aggregate demand curve Consumption Spending ( C ) aggregate demand buying goods and services cheaper today A increase in expected inflation Consumption Spending ( C ) rightward shift of the aggregate demand curve aggregate demand

aggregate demand curve Factors that shift the Aggregate Demand Curve 2. Investment Spending (I) The following factors can cause investment spending to change: a) Interest Rates; b) Corporate Profits Taxes; and c) Expectations about Future Sales. a) Interest Rates The interest rates borrowing by investors Investment Spending ( I ) rightward shift of the aggregate demand curve aggregate demand

aggregate demand curve Factors that shift the Aggregate Demand Curve b) Corporate Profits Taxes Taxes on profits of firms firms after-tax profits Investment Spending ( I ) rightward shift of the aggregate demand curve aggregate demand

aggregate demand curve Factors that shift the Aggregate Demand Curve c) Expectations about Future Sales Expected future sales profits expectations Investment Spending ( I ) today rightward shift of the aggregate demand curve aggregate demand

3. Government Spending (G) Factors that shift the Aggregate Demand Curve 3. Government Spending (G) An increase in government purchases of goods and services increases aggregate demand. This shifts the aggregate demand curve to the right 4. Net Exports (NX) The following factors can cause net exports to change: a) Foreign Real Income; and b) Foreign Exchange Rate.

(Real GDP of foreign countries) aggregate demand curve Factors that shift the Aggregate Demand Curve a) Foreign Real Income Foreign real income (Real GDP of foreign countries) The exports of the home country rightward shift of the aggregate demand curve aggregate demand AD = C + I + G + X - M

Factors that shift the Aggregate Demand Curve b) Foreign Exchange Rate The prices of domestic goods and services relative to foreign goods and services Foreign exchange rate (price of foreign currency ) Exports and Imports Net exports rightward shift of the aggregate demand curve aggregate demand

The Meaning of Aggregate Supply Aggregate supply, AS is the quantity supplied of all final goods and services (Real GDP) at different price levels. ). This is represented by the aggregate production function: Y = f (N, K, L, T) Where: Y = The aggregate supply (Real GDP); f = depends on; N = Labor; K = Capital; L = Land; T = The State of Technology.

The short-Run Aggregate Supply Curve The Short-Run Aggregate Supply, SRAS curve is upward-sloping, specifying a positive relationship between the price level as independent variable and the quantity supplied of real GDP as dependent variable.

3.2.2.2 The Long-Run Aggregate Supply Curve Page 75 till Figure 3.11: A Change in Aggregate Supply in the Short-Run: Shifts of the Short-Run Aggregate Supply Curve page 81 and 3.3.2 Long-Run Macroeconomic Equilibrium page 82

1 Short-Run macroeconomic Equilibrium When the quantity demanded of real GDP equals the quantity supplied of real GDP, the Short-Run macroeconomic equilibrium occurs The short-run equilibrium point (n) is the interaction of the AD curve and SRAS curve. This intersection determines the equilibrium price level (Pe) and the equilibrium real GDP (Ye).