Chapter 22 Aggregate Demand and Aggregate Supply ©2000 South-Western College Publishing

2 GDP Deflator A price index that measures the overall changes in prices of everything in GDP

3 Aggregate Demand Curve Shows an inverse relationship between the overall price level and the quantity of real output that will be demanded at various price levels, ceteris paribus

4 Price Index.95 The Aggregate Demand Curve Exhibit AD $1,300 $1,500 $1,700 Real GDP (billions) 1.05

5 Why the Aggregate Demand Curve Slopes Downward 1. The real balance or wealth effect 2. The substitution of foreign goods effect 3. The constant nominal income effect Exhibit

6 Wealth Effect, or Real Balances Effect The change in the supply of real balances, which causes an increase or decrease in wealth, when the price level changes for a given supply of nominal money balances

7 Substitution-of-Foreign Goods Effect When changes in the domestic price level cause consumers to substitute into relatively cheaper foreign goods or out of relatively more expensive foreign goods

8 Constant Nominal Income Effect When changes in the price level necessarily cause the quantity demanded to change in the opposite direction to maintain the constant nominal purpose

9 Price Index 1.0 The Shift in Aggregate Demand Curve Exhibit A AD AD' $1,500 $2,000 Real GDP in billions A'

10 Exhibit Money Supply Interest Rates Government Spending & Taxes Exchange Rates Capital Flows U.S. Monetary Policy U.S. Fiscal Policy Foreign Policies & Developments Interest Rates, Stock Prices, Exchange Rates, Expected Inflation, Economic Outlook Consumption InvestmentGovernmentNet Exports Aggregate Demand & Income

11 Aggregate Supply Curve The curve graphically depicting the relationship between the overall price level and the quantity of real GDP that will be supplied at various price levels

12 Long-Run Equilibrium When all prices, including wages, have fully adjusted to previous shifts in aggregate supply or demand and the flow of spending, saving, borrowing and lending continues until something else changes

13 Real Wage = nominal wage overall price level

14 Short-Run Aggregate Supply Curve Shows the direct relationship between the overall price level and the level of real output that will be supplied in response to changes in demand before full adjustment of relative price has taken place

15 Natural Level of Real Output The level of real output that is consistent with long-run equilibrium given the economy’s quantity and productivity of the factors of production

16 Price Index.95 Short Run Aggregate Supply Exhibit AD $1,300$1,500$1,700 Real GDP (billions) 1.05 AD' SRAS AD'' B A C

17 Determinants of the Natural Level of Real Output 1. The economy’s capital stock 2. Natural resources 4. The labor force 3. Technological know-how 4. Institutional arrangements concerning the labor market and other input markets Exhibit

18 Long-Run Aggregate Supply Curve The vertical curve through the natural rate of output to which the economy will return in the long run, regardless of the price level

19 Price Index 1.0 The Long-Run Aggregate Real Supply Exhibit A AD AD' Real GDP B 1.10 LRAS

20 Price Index 1.00 Shifts in Short-Run Aggregate Supply Exhibit A AD' Real GDP in billions 1.10 LRAS B C 1.05 D AD SRAS'' SRAS' SRAS $1,500$1,700

21 Demand-Pull Inflation Sustained increases in the overall price level due to high levels of demand

22 Net Incurring of Financial Liabilities The incurring of debt

23 Net Acquisition of Financial Assets The purchasing of financial assets

24 Net Financial Investment When the net acquisition of financial assets is greater than the net incurring of financial liabilities within a given sector

25 Net Financial Deficit When the net incurring of financial liabilities is greater than the net acquisition of financial assets within a given sector