1. Aggregate Demand and Supply

2. 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

3. Aggregate Demand Downward Slope
Real Balance Effect (Wealth Effect)
Consumers spend more on goods and services because lower prices make their dollars more valuable
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

4. Aggregate Demand Curve
200
150
Price Level
100 AD 50 2 4 6 8 10 12
Real GDP

5. Shifts in Aggregate Demand Curve
Consumption:
Income: there is a direct relationship between changes in real disposable income and changes in consumption
Expectations: Consumers expectations of things to happen in the future will affect their spending decisions today
Wealth: There is a direct relationship between a change in wealth and a change in consumption
Interest rates: There is an indirect relationship between a change in interest rates and a change in consumption

6. Shifts in Aggregate Demand Curve
Investments:
Expectations: Investors are susceptible to moods of optimism and pessimism
Technological change: New products and new ways of doing things have a big impact on investment decisions
Capacity utilization:
For low utilization firms can meet an increase in demand without expanding
For high utilization firms must increase investment to meet an increase in demand
Business taxes: Business decisions depend on the expected after-tax rate of profit
Interest Rate: There is an indirect relationship between a change in interest rates and a change in investment, all else equal

7. a shift in the aggregate demand curve
Increases in C, I, G, (X-M)
lead to
a shift in the aggregate demand curve
200
AD2
150
Price Level (CPI)
100 50
AD1 2 4 6 8 10 12
Real GDP

8. Classical economists ideals were widely accepted prior to the 1930’s
Classical economists believed the economy always tends toward full employment equilibrium
Full Employment theory: Producers produce goods consumers want and consumers have the money to buy because of the wages they were paid
unemployment is possible, but it is a short-lived adjustment period in which wages and prices decline or people voluntarily choose not to work

9. Aggregate Supply Curve
Shows the level of real GDP produced at different price levels during a time period, ceteris paribus
Classical economist assume flexible product prices and wages
Producers lower prices to sell additional output
Idle resources mean wage and factor price negotiation: Unemployed workers are willing to work for lower wages to become re-employed
A vertical aggregate supply curve explains flexible prices and wages
and the vertical supply curve is at the full employment output (in the long run)

10. Classical Vertical Aggregate Supply
200
150
unemployment
Full employment
Price Level (CPI)
100
AD1 50
AD2 2 4 6 8 10 12 14 16 17
Real GDP

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

12. Keynesian Model Then comes the Great Depression of the 1930’s
Extended long term unemployment for which the classical model did not explain
Keynesian Model
John Maynard Keynes: A British economist ( ) who offered an explanation of the Great Depression of the 1930’s
Keynes wrote: “The General Theory of Employment, Interest, and Money”
Keynes’ theory suggest demand can be forever inadequate for an economy to achieve full employment

13. Keynesian Horizontal Aggregate Supply
full employment
200
AD2
AD1
150
Price Level (CPI)
100 AS 50 2 4 6 8 10 12
Real GDP

14. Price level remains constant, while real GDP and employment rise
Aggregate demand increases and the economy grows
Government spending (G) increases

15. Understanding the Different Theories
Classical economists believe the economy normally operates at its full employment in the long run
the price level of products and production costs change by the same percentage in order to maintain full employment
Say’s Law: Supply creates it’s own demand
Keynesians economists believe that because prices and wages are inflexible the economy can have long term unemployment
shifts in aggregate demand will restore a depressed economy to full employment
in the long run we’re all dead

16. YF Ranges of the Aggregate Supply Curve AS Price Level Real GDP
Classical Range
Price Level
Full Employment
Intermediate Range
Keynesian Range YF
Real GDP

17. Increasing Demand AS 200 150 100 50 2 4 6 8 10 12 AD6 AD5 AD4 AD3 AD22 4 6 8 10 12
Full Employment

18. Rightward Shift in the Aggregate Supply Curve
AS1
200
AS2
Resource prices
Taxes
Subsides
Technological change
Regulation
150
Price Level
100 AD 50 2 4 6 8 10 12 14 16 17
Real GDP

19. Types of Inflation Cost Push Inflation Demand Pull Inflation Cost push
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

20. Cost Push Inflation (Stagflation)
AS2
AS1
200
150
Price Level
100 50 AD 2 4 6 8 10 12 14 16 17
Real GDP

21. Demand Pull Inflation Price Level Real GDP AD2 AS 200 150 100 50 AD1 24 6 8 10 12 14 16 17
Real GDP

22. Explaining the Business Cycle
AD2
200
AS2
AS1
150
Price Level
100 50
AD1 2 4 6 8 10 12 14 16 17
Real GDP