1. Aggregate Demand and Aggregate Supply
Topic 9
Aggregate Demand and Aggregate Supply

2. The Aggregate Demand Curve
When price level rises, money demand curve shifts rightward
Consequently, interest rate is higher, given money supply is fixed
Then, aggregate expenditure decreases (AE line shifts downward)
As a result, the equilibrium GDP becomes lower
So,
a rise in price level causes a decrease in equilibrium GDP.
The aggregate demand curve shows the negative relationship between price levels and equilibrium real GDP

3. Figure 1: Deriving the Aggregate Demand Curve

4. Understanding the AD Curve
Each point on the AD curve represents a short-run equilibrium in economy
The AD curve is different from a demand curve for one particular product

5. Movements of the AD Curve
Moving along the AD curve whenever price level changes
When anything other than price level cause equilibrium GDP to change, the AD curve shifts
Government purchasing
Taxes
Autonomous consumption spending
Investment spending
Net exports
Money supply
Expectations

6. Figure 2: A Spending Shock Shifts the AD Curve

7. Costs and Prices
To understand how macroeconomic events affect the price level, we assume
A firm sets price of its products as a markup over cost per unit
So, in the short-run, price level rises when there is an economy-wide increase in unit costs
Labor costs
Costs of natural resources
How an increase in output level raises the price level?
As output increases, demand for inputs rises
As unit cost increases, price level ( assumed as a markup over unit cost) rises

8. Figure 3: The Aggregate Supply Curve

9. Movements of the AS Curve
When price level changes due to a change in real GDP, the change happens along the AS curve
When the change of price level is caused by any factor other than real GDP, the AS curve shifts
Oil prices
Weather
Technological change
Nominal wage

10. Figure 4: Shifts of the Aggregate Supply Curve

11. Figure 5: Short-Run Macroeconomic Equilibrium

12. Figure 6: The Effect of a Demand Shock

13. An Increase in Government Purchases
When G rises, AD curve shifts rightward. As a result, real GDP rises, given price level is fixed.
However, when real GDP rises, unit cost goes up, so does price level.
Furthermore, as price level goes up, Md and interest rate increase too, which causes aggregate expenditure to fall.
In the end, real GDP increases by less than horizontal shift in AD curve.

14. An Increase in the Money Supply
Can you demonstrate how an increase in the money supply affects the real equilibrium GDP?

15. Demand Shocks A positive demand shock—shifts AD curve rightward
Increases both real GDP and price level in short-run
A negative demand shock—shifts AD curve leftward
Reduces both real GDP and price level in short-run

16. Examples The Great Depression 1929 – 1933
Negative demand shocks
Oil Crisis 1973 (began on October 17)
Negative supply shocks

17. Demand Shocks: Adjusting to the Long-Run
In short-run, wage rate is treated as given
But in long-run, wage rate can change
When output is above full employment, wage rate will rise, shifting AS curve upward
When output is below full employment, wage rate will fall, shifting AS curve downward

18. Figure 7: The Long-Run Adjustment Process After A Positive Demand Shock

19. Figure 8: Long-Run Adjustment After A Negative Demand Shock

20. Figure 9: The Effect of a Supply Shock

21. More examples 1990-91 recession 2001 recession
Oil supplies drop and price of oil goes up.
2001 recession
Money supply decreases and interest rate increases.

22. Inflation and Unemployment
Low inflation and unemployment
Fed’s major goals
Compatible or conflicting?
Short-run tradeoff
Supply shocks cause both rates to rise
No long-run tradeoff

23. The Phillips Curve

24. The Phillips Curve (cont’)
Demonstrates short-run tradeoff between inflation and unemployment

25. The Phillips Curve
No long-run tradeoff between inflation and unemployment
Short-run Phillips curve
Role of expected inflation
Long-run vertical Phillips curve
Disinflation vs. Reflation

26. The Long Run Phillips Curve