1. AGGREGATE DEMAND (AD): The quantity of real GDP demanded at different price levels. -The price level is measured using the GDP deflator. -The quantity of real GDP demanded is composed of C+I+G+(X-M) -The AD curve is NOT the same as a market demand curve. -A market demand curve illustrates the total demand of all consumers for ONE particular product. The AD curves illustrates the total demand of all agents in the economy for all goods and services in the economy.

2. The AD Curve: Negatively sloped.

3. Wealth effect: (aka real balances effect, Pigou effect) Real wealth is the amount of money in the bank, bonds, stocks and other assets people own (ex: art) measured in terms of what they will buy. Wealth effect: (aka real balances effect, Pigou effect) Real wealth is the amount of money in the bank, bonds, stocks and other assets people own (ex: art) measured in terms of what they will buy. People save and hold money, bonds and stocks. One reason is to build up funds for future spending (ex: college fund or retirement savings). People save and hold money, bonds and stocks. One reason is to build up funds for future spending (ex: college fund or retirement savings). If price level, real wealth. People then try to restore their real wealth by increasing their saving and decreasing consumption. So the quantity of real GDP demanded falls (movement ALONG the AD curve) If price level, real wealth. People then try to restore their real wealth by increasing their saving and decreasing consumption. So the quantity of real GDP demanded falls (movement ALONG the AD curve)

4. Substitution effect: (International and intertemporal). Substitution effect: (International and intertemporal). An in the P L means the price of domestic goods is changing relative to the prices of foreign goods…foreign goods could be more attractive due to this change is relative prices. Thus M and X (which are relatively more expensive to the foreigners buying them). Domestic goods are substituted by foreign goods. An in the P L means the price of domestic goods is changing relative to the prices of foreign goods…foreign goods could be more attractive due to this change is relative prices. Thus M and X (which are relatively more expensive to the foreigners buying them). Domestic goods are substituted by foreign goods. An in the P L also means people need more money to maintain C, so they borrow money. This the interest rate. Opportunity cost of C is now higher so people save more…savings now allows for higher consumption in future. Thus current spending is substituted by spending in the future (intertemporal: Occurring across time, or across different periods of time. An in the P L also means people need more money to maintain C, so they borrow money. This the interest rate. Opportunity cost of C is now higher so people save more…savings now allows for higher consumption in future. Thus current spending is substituted by spending in the future (intertemporal: Occurring across time, or across different periods of time.

5. Interest Rate Effect Interest Rate Effect As mentioned, an in the P L tends to interest rates as it costs more to buy things and people tend to borrow to maintain their spending. As mentioned, an in the P L tends to interest rates as it costs more to buy things and people tend to borrow to maintain their spending. The more borrow (because of an increase in money demand) pushes up the price of money...which is the interest rate. The more borrow (because of an increase in money demand) pushes up the price of money...which is the interest rate. As the interest gets higher it becomes too costly to borrow and people tend to buy fewer expensive goods (ex: houses, cars, luxury vacations, renovations) and the quantity of real GDP demand tends to falls. As the interest gets higher it becomes too costly to borrow and people tend to buy fewer expensive goods (ex: houses, cars, luxury vacations, renovations) and the quantity of real GDP demand tends to falls.

6. NOTE: NOTE: In text on page 345 the real income effect is discussed. The real income effect only holds true if nominal wages remain constant as price level is falling. For workers on a contract it can be very difficult to lower wages BUT for new employees the wage rate will probably be lower and if their nominal wage is less than what it was then the real income effect does not hold. But the real wealth effect does as it is not tied to income. In text on page 345 the real income effect is discussed. The real income effect only holds true if nominal wages remain constant as price level is falling. For workers on a contract it can be very difficult to lower wages BUT for new employees the wage rate will probably be lower and if their nominal wage is less than what it was then the real income effect does not hold. But the real wealth effect does as it is not tied to income. RECALL: wages are the PRICE employees pay to hire workers...as price falls ALL prices fall, not only prices of consumption goods. RECALL: wages are the PRICE employees pay to hire workers...as price falls ALL prices fall, not only prices of consumption goods.

7. NOTE: NOTE: The interest rate effect can be tricky! If changes in the price level are CAUSING the change in the interest rate then the change in the interest rate is linked to a movement along the AD curve. The interest rate effect can be tricky! If changes in the price level are CAUSING the change in the interest rate then the change in the interest rate is linked to a movement along the AD curve. BUT the government can change the level of the interest rate completely separately from any changes in the price level. In this case the change in the interest rate will cause a SHIFT of the AD curve. BUT the government can change the level of the interest rate completely separately from any changes in the price level. In this case the change in the interest rate will cause a SHIFT of the AD curve.

8. SHIFTS OF AD SHIFTS OF AD

9. Shifts of the AD Curve AD = C + I + G + (X-M) AD = C + I + G + (X-M) Anything that cause a change in any of the componets of AD will cause AD to shift. Anything that cause a change in any of the componets of AD will cause AD to shift. EX:C: changes in consumer wealth, expectations, taxes, indebtedness will each causes the level of AD to change (at the given price level!!) EX:C: changes in consumer wealth, expectations, taxes, indebtedness will each causes the level of AD to change (at the given price level!!) I: changes in interest rates, profit expectations or investment opportunities, business taxes excess capacity and/or technology will each cause changes in AD for firms. I: changes in interest rates, profit expectations or investment opportunities, business taxes excess capacity and/or technology will each cause changes in AD for firms. G: Changes in government spending. The use of fiscal and/or Monetary policy will cause AD to shift. G: Changes in government spending. The use of fiscal and/or Monetary policy will cause AD to shift. Net Exports: exchange rates, foreign national income/GDP Net Exports: exchange rates, foreign national income/GDP

10. Aggregate Supply (AS) The AS: the relationship between the quantity of real GDP supplied and the price level. The shape of the AS curve differs in the short run and the long run. The short run AS curve (SRAS)

11. The KEYNESIAN INTERVAL: (aka the depressionary interval) is horizontal. This indicates that the quantity of real GDP can be increased or decreased without having any impact on the price level. The KEYNESIAN INTERVAL: (aka the depressionary interval) is horizontal. This indicates that the quantity of real GDP can be increased or decreased without having any impact on the price level. This can only happen if there is such an abundance of unused resources available that the use of some of them does not threaten a shortage of them. This can only happen if there is such an abundance of unused resources available that the use of some of them does not threaten a shortage of them.

12. Intermediate range Over this range any attempt to increase the quantity of real GDP causes there to be an increase in the price level. There is no longer an over abundance of resources. It is now the case that resources start to become more scarce and different firms compete to own these resources. Over this range any attempt to increase the quantity of real GDP causes there to be an increase in the price level. There is no longer an over abundance of resources. It is now the case that resources start to become more scarce and different firms compete to own these resources. The greater the increase in real GDP the more scarce the resources become and the greater the pressure on the price level to rise. The greater the increase in real GDP the more scarce the resources become and the greater the pressure on the price level to rise.

13. The Classical Range/Physical capacity The SRAS curve becomes vertical at the maximum physical capacity the economy is capable of producing. All resources are being used to their maximum capacity. The SRAS curve becomes vertical at the maximum physical capacity the economy is capable of producing. All resources are being used to their maximum capacity. Any attempt to increase real GDP fails…the only consequence is an increase in the price level… Any attempt to increase real GDP fails…the only consequence is an increase in the price level… WHY does the price level increase? WHY does the price level increase?

14. Shifts of AD over different ranges of SRAS

15. Long Run Supply Curve (LRAS)

16. SRAS and LRAS