Aggregate Demand and Supply

Aggregate Demand Curve shows the level of real GDP purchased by everyone at different price levels during a time period, ceteris paribus The horizontal axis measures the value of final goods and services included in real GDP measured in base year dollars The vertical axis measure is an index of the overall price level, such as the GDP deflator or the CPI Aggregate Demand Curve slopes downward to the right Real balance wealth effect Interest rate effect Net exports effect

Interest Rate Effect Assuming fixed credit, an increase in the price level translates through higher interest rates into a lower real GDP Net Exports Effect A higher domestic price level makes U.S. goods more expensive compared to foreign goods, exports decrease, imports increase, decreasing real GDP Real Balance Effect Consumers spend more on goods and services because lower prices make their dollars more valuable Aggregate Demand Downward Slope

$200 $150 $100 $ B A AD Aggregate Demand Curve Price Level Real GDP

Shifts in Aggregate Demand Curve Consumption, Investments, Government spending and Net exports can change

BA AD 2 AD 1 Shift in Aggregate Demand Curve Price Level (CPI) Real GDP

Increases in C,I, G, (X-M) Increases (shifts) in the aggregate demand curve lead to

Aggregate Supply Curve Shows the level of real GDP produced at different price levels during a time period, ceteris paribus Keynes assumes fixed product prices and wages During a deep recession or depression, there are many idle resources in the economy Producers are willing to sell additional output at current prices because there is plenty of resources to go around for everyone who wants them Idle resources mean fixed wages: Unemployed workers willing to work for the prevailing wage diminishes the power of workers to increase their wages

What kind of supply curve would explain fixed prices and wages? A horizontal supply curve

Real GDP Price Level (CPI) 12 AS AD 2 AD 1 Keynesian Horizontal Aggregate Supply Curve full employment 10

Government spending (G) increases Aggregate demand increases and the economy moves from E 1 to E 2 Price level remains constant, while real GDP and employment rise

Keynesians believe what a shift in aggregate demand will restore a depressed economy to full employment Classical view of the aggregate supply curve a vertical line at the full employment output Classical economists believe Understanding the Different Theories the economy normally operates at its full employment level the price level of products and production costs change by the same percentage in order to maintain full employment

Real GDP Full employment Classical Aggregate Supply Curve AS Price Level (CPI) 17 AD 1 AD 2 Surplus

Aggregate demand decreases at full employment Unemployment causes a decrease in prices The economy moves to a level of full employment

YKYK Real GDP Keynesian Range Ranges of the Aggregate Supply Curve AS Price Level Intermediate Range Classical Range YFYF Full Employment

AS 0 $50 $100 $150 $200 Full Employment AD 1 AD 3 AD 4 Increasing Demand AD 6 AD 5 AD 2

full employment Rightward Shift in the Aggregate Supply Curve Price Level 17 AS 1 AD AS 2 Real GDP

Types of Inflation Cost push Demand pull Cost Push Inflation A rise in the general price level resulting from an increase in the cost of production Demand Pull Inflation A rise in the general price level resulting from an excess of total spending

Price Level 17 AD AS 1 Real GDP AS 2 Cost Push Inflation

Price Level 17 AD 1 AS Real GDP AD 2 Demand Pull Inflation

Stagflation High unemployment and rapid inflation exist simultaneously The business cycle Shifts in the aggregate demand and aggregate supply curves Other Shifts in AD & AS

AD 1 AS 1 Real GDP AD 2 AS 2 Rightward Shift in Demand and Supply Price Level

Increase in aggregate demand and supply Increase in real GDP Increase in price level