1. Chapter 29 Aggregate Demand and Aggregate Supply McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Chapter Objectives Aggregate demand (AD) Aggregate supply (AS)
How AD and AS determine equilibrium price and real GDP
The AD-AS model

3. Aggregate Demand Amount of real GDP purchased at each price level
Why the downward slope?
No income or substitution effect
Real-balances effect: purchasing power of held assets (C)
Interest-rate effect: demand for $ (I)
Foreign purchases effect (X)
Consumption, investment, and net exports

4. Aggregate Demand Curve
Price Level AD
Real Domestic Output, GDP

5. Aggregate Demand Determinants of aggregate demand
Fixed variables along the demand curve
Change in fixed variable (C I G X)
Multiplier effect
Consumer spending variables:
Consumer wealth: value of assets
Consumer expectations: income and prices
Household borrowing: borrowing vs. repaying
Personal taxes

6. Aggregate Demand Investment spending variables
Real interest rates (related to money supply)
Expected returns on investment
Future business conditions
Technology
Degree of excess capacity
Business taxes
r = i

7. Aggregate Demand Government spending Net export spending variables
Remember - Non-transfers only
Net export spending variables
National income abroad
Exchange rates

8. Dempsey may have gained us a point…
…but Gerrard can take solace in the favorable exchange rate.

9. Changes in Aggregate Demand
Increase in
Aggregate
Demand
Price Level
Decrease in Aggregate
Demand
AD2
AD1
AD3
Real Domestic Output, GDP

10. Aggregate Supply Amount real GDP produced at each price level
Three time horizons
Immediate short run
Few days to a few months
All prices fixed (input and output)
Implicit price agreements (output)
Contractual agreements (input)

11. Immediate-short-run Aggregate Supply
ASISR
Price Level
Immediate-short-run Aggregate Supply Qf
Real Domestic Output, GDP

12. Aggregate Supply

13. Aggregate Supply Short run Long run Input prices fixed
Output prices variable
Real profit changes
Long run
All prices variable
Full employment GDP
All prices adjust

14. Aggregate Supply
Slope not constant: per unit production cost and firm capacity
Aggregate Supply
(Short Run)
Competition for resources hikes ATC
Price Level
Plentiful resources limit growth of ATC Qf
Real Domestic Output, GDP

15. Aggregate Supply Long-run Aggregate Supply ASLR Price LevelQf
Real Domestic Output, GDP

16. Aggregate Supply Determinants of aggregate supply
Change in input price (land, labor, capital)
Domestic resource prices
Prices of imported resources
Change in productivity
Change in legal-institutional environment
Business taxes and subsidies
Government regulation

17. Aggregate Supply AS3 Decrease in AS1 Aggregate Supply AS2 Increase in
Price Level
Increase in
Aggregate
Supply
Real Domestic Output, GDP

18. Equilibrium Price Level and
Real Output
Demanded
(Billions)
Real Output
Supplied
(Billions)
Price Level
(Index Number)
$506
508
510
512
514
108
104
100 96 92
$513
512
510
507
502
Equilibrium Price Level and
Equilibrium Real GDP

19. Real Domestic Output, GDP
Equilibrium AS
Price Level
Equilibrium
100 92 a b AD
502
510
514
Real Domestic Output, GDP
(Billions of Dollars)

20. Changes in Equilibrium
Increase in Aggregate Demand AS
Demand-Pull
Inflation P2
Price Level P1
AD1 AD
**increase in price level diminishes the multiplier effect Qf Q1 Q2
Real Domestic Output, GDP

21. Changes in Equilibrium
Decrease in Aggregate Demand AS
Price Level b P1 a P2 c
Creates a
Recession
**No change in price level protects full multiplier effect
AD1
AD2 Q1 Q2 Qf
Real Domestic Output, GDP 21

22. Changes in Equilibrium
Decrease in aggregate demand
Recession and cyclical unemployment
Deflation?
Downward price inflexibility:
Fear of price wars
Menu costs
Wage contracts
Morale, effort, and productivity
Efficiency wages: output per hour of input
Minimum Wage

23. Real Domestic Output, GDP
Changes in Equilibrium
Decrease in Aggregate Supply
AS2
AS1
Cost-Push
Inflation b P2
Price Level a P1 AD Q1 Qf
Real Domestic Output, GDP

24. Real Domestic Output, GDP
Changes in Equilibrium
Increases in Aggregate Supply –
Full-Employment With Price-Level Stability
AS1
AS2 P3 b P2 c P1 a
Price Level
AD2
AD1 Q1 Q2 Q3
Real Domestic Output, GDP

25. Impact of Oil Prices Aggregate supply shocks Cost push inflation
Oil prices affected core inflation prior to 1980
Core inflation unaffected post 1980
Energy efficiency
Composition of GDP
Fed vigilance

26. Key Terms aggregate demand-aggregate supply (AD-AS) model
real-balances effect
interest-rate effect
foreign purchases effect
determinants of aggregate demand
aggregate supply
immediate-short-run aggregate supply curve
short-run aggregate supply curve
long-run aggregate supply curve
determinants of aggregate supply
productivity
equilibrium price level
equilibrium real output
menu costs
efficiency wages

27. Next Chapter Preview…
Fiscal Policy,
Deficits, and Debt

28. Appendix
The Relationship of the Aggregate Demand Curve to the Aggregate Expenditures Model

29. Aggregate Expenditures
Deriving the AD Curve
AE1 (at P1 )
AE2 (at P2 )
AE3 (at P3 )
As Price Levels Increase…
Aggregate Expenditures
(billions of dollars)
45° P3
Real GDP
Declines
Price Level P2 P1 AD Q1 Q2 Q3
Real Domestic Product, GDP

30. Aggregate Expenditures
Deriving the AD Curve
Price Level
Aggregate Expenditures
45°
Real Domestic Product, GDP
AE2 (at P1 )
AE1 (at P1 )
Increase in Aggregate
Expenditures
Increase in
Aggregate
Demand P1
AD2
AD1 Q1 Q2

31. Aggregate Expenditures
Deriving the AD Curve
Price Level
Aggregate Expenditures
45°
Real Domestic Product, GDP
AE2 (at P1 )
AE1 (at P1 )
The Shift in the
Aggregate Demand
Curve is a Multiple
of the initial Change
in Aggregate
Expenditures P1
AD2
AD1 Q1 Q2