1. 11
C H A P T E R
Aggregate Demand
and
Aggregate Supply

2. AGGREGATE DEMAND
Defined: The amounts of real output that buyers collectively desire to purchase at each possible price level
Aggregate Demand Curve
Down Sloping Due To:
Real-Balances Effect
When price level falls, the purchasing power of existing financial balances (like savings) rises, which can increase spending
Interest-Rate Effect
A decline in price level means lower interest rates which can increase levels of certain types of spending
Foreign Purchases Effect
When price level falls US prices will fall relative to foreign prices, which will tend to increase spending on US exports and decrease import spending in favor of US products that compete with imports

3. Aggregate expenditures
DERIVATION OF THE AGGREGATE DEMAND CURVE
AE1 at P 1 1
AE2 at P 2
AE3 at P 3
Aggregate expenditures
(billions of dollars) 2 3
GDP3
GDP2
GDP1 3’ P3
The Aggregate Demand
Can Be Constructed
Price level 2’ P2 1’ P1 AD
GDP3
GDP2
GDP1

4. CHANGES IN AGGREGATE DEMAND
Can Increase
Price level
AD2
AD1
Real domestic output, GDP

5. CHANGES IN AGGREGATE DEMAND
Can Increase
…or Decrease
Price level
AD1
AD3
Real domestic output, GDP

6. Change in Consumer Spending
DETERMINANTS OF AGGREGATE DEMAND
Change in Consumer Spending
Consumer Wealth (Stocks, housing prices)
Consumer Expectations
Consumer Indebtedness (When debt is high current spending may be cut)
Taxes
Change in Investment Spending
Real Interest Rates
Expected Returns
Expected Future Business Conditions
Technology
Degree of Excess Capacity
Business Taxes

7. Government Spending Net Export Spending National Income Abroad
DETERMINANTS OF AGGREGATE DEMAND
Government Spending
Net Export Spending
National Income Abroad
Exchange Rates
Changes in Aggregate Demand Shifts
and the Aggregate Expenditures Model
Illustrated…

8. Increase in Aggregate Expenditures Increase in Aggregate Demand
SHIFTS IN THE AGGREGATE EXPENDITURES
SCHEDULE & THE AGGREGATE DEMAND CURVE
AE2 at P 2
AE1 at P 1
Aggregate expenditures
(billions of dollars)
Increase in
Aggregate
Expenditures
GDP1
GDP2
Increase in
Aggregate
Demand
Price level P1
AD2
AD1
GDP1
GDP2

9. AGGREGATE SUPPLY
Defined: The amounts of real output that firms will produce at each possible price level
Higher Price Levels Provide An Incentive to Produce More
Aggregate Supply Has Three Segments or Ranges:
1 - Horizontal Range
2 - Intermediate (Upsloping) Range
3 - Vertical Range

10. AGGREGATE SUPPLY P Q Vertical Range Price level Upsloping or
Horizontal
Range
Upsloping or
Intermediate
Range Q
Real domestic output, GDP

11. AGGREGATE SUPPLY Changes in Aggregate Supply P Q Decrease In Aggregate
Price level
Increase In
Aggregate
Supply Q
Real domestic output, GDP

12. Domestic Resource Availability Land Labor Capital
DETERMINANTS OF AGGREGATE SUPPLY
Change in Input Prices
Domestic Resource Availability
Land
Labor
Capital
Entrepreneurial Ability
Prices of Imported Goods
Market Power

13. Change in Productivity
DETERMINANTS OF AGGREGATE SUPPLY
Change in Productivity
Productivity =
Real Output
Input
Change in Legal-Institutional Environment
Business Taxes and Subsidies
Government Regulation

14. EQUILIBRIUM: REAL OUTPUT
AND THE PRICE LEVEL P AS
Equilibrium in the
Intermediate Range
Price Level Pe P1 AD Q Q1 Qe Q2
Real Domestic Output, GDP

15. EQUILIBRIUM: REAL OUTPUT
AND THE PRICE LEVEL P AS
Equilibrium in the
Horizontal Range
Price Level Pe AD Q Q1 Qe Q2
Real Domestic Output, GDP

16. CHANGES IN EQUILIBRIUM
Increasing Demand in the Horizontal Range P AS
AD1
Price Level P1
AD2 Q Q1 Q2
Real Domestic Output, GDP

17. CHANGES IN EQUILIBRIUM
Increasing Demand in the Intermediate Range P AS
Price Level P4 P3
AD3
AD4 Q Q3 Q4
Real Domestic Output, GDP

18. CHANGES IN EQUILIBRIUM
Increasing Demand in the Vertical Range P AS P6
Price Level P5
AD6
AD5 Q Qc
Real Domestic Output, GDP

19. MULTIPLIER WITH PRICE-LEVEL CHANGES
Inflation and the Multiplier
Full Multiplier
Effect AS
Reduced
Multiplier
Effect Due
to Inflation
Price Level P2 P1
AD3
AD2
AD1
GDP1
GDP2
GDP3
Real Domestic Output, GDP

20. DECREASES IN AD AND RECESSION
Decreasing Demand That Causes A Recession
Recession and Cyclical Unemployment
Wage Contracts
Morale, Effort, and Productivity
Efficiency Wages
Minimum Wage
Menu Costs
Fear of Price Wars

21. DECREASES IN AD AND RECESSION
Decreasing Demand That Causes A Recession AS
AD2
Price Level P1
AD1 Q2 Q1
Real Domestic Output, GDP

22. DECREASES IN AD AND RECESSION
Decreasing Supply That Causes A Recession
AS2
AS1 P2
Price Level P1 AD Q2 Q1
Real Domestic Output, GDP

23. INCREASES IN AS AND INFLATION
Increasing Supply: Full-Employment and Price-Level Stability
AS1
AS2 P3
Price Level P2 P1
AD2
AD1 Q1 Q2 Q3
Real Domestic Output, GDP

24. INCREASES IN AS AND INFLATION
Increasing Supply: Full-Employment and Price-Level Stability
AS1
AS2
Chapter
Conclusions P3
Price Level P2 P1
AD2
AD1 Q1 Q2 Q3
Real Domestic Output, GDP

25. KEY TERMS aggregate demand-aggregate supply (AD-AS) model
real-balances effect
interest-rate effect
foreign purchases effect
determinants of aggregate demand
aggregate supply
horizontal range (of AS curve)
intermediate range (of AS curve)
vertical range (of AS curve)
determinants of aggregate supply
productivity
equilibrium price level
equilibrium real output
efficiency wages
menu costs
BACK
END
Copyright McGraw-Hill/Irwin, 2002

26. Coming next...
FISCAL
POLICY
Chapter 12