1. Copyright © 2002 Pearson Education, Inc. Aggregate Demand Aggregate demand for current output, Y d, is: Y d = C + I + G + NX. The AD curve slopes downward because an increase in the price level reduces the aggregate demand for output: P up …(M/P) falls … wealth falls … C down P up …(M/P) falls … real interest rate up … C and I down P up …(M/P) falls … real rate up … $ rises … NX down P up …Exports fall and Imports rise

2. Copyright © 2002 Pearson Education, Inc. Slide 25-2 Aggregate Demand Curve

3. Copyright © 2002 Pearson Education, Inc. Slide 25-3

4. Copyright © 2002 Pearson Education, Inc. Aggregate Supply The aggregate supply curve shows the output supplied at each price level. The short-run aggregate supply curve slopes upward New Classical “misperceptions” New Keynesian stick prices: long-term and staggered contracts, menu costs The long-run aggregate supply curve is vertical at full employment output, Y *  The Green Shaft The LRAS shifts over time to reflect growth in the full- employment level of output Changes in productivity Technology Incentives Increases in Kapital stock and in laborforce

5. Copyright © 2002 Pearson Education, Inc. Slide 25-5 The Short-Run and Long-Run Aggregate Supply Curves

6. Copyright © 2002 Pearson Education, Inc. Slide 25-6

7. Copyright © 2002 Pearson Education, Inc. Equilibrium The short-run equilibrium occurs at the intersection of the AD and SRAS curves. In the long run the price level adjusts and output returns to Y * …The GREEN SHAFT The real business cycle view argues short-term output changes due to productivity shocks.

8. Copyright © 2002 Pearson Education, Inc. Slide 25-8 Short-Run Equilibrium

9. Copyright © 2002 Pearson Education, Inc. Slide 25-9 Adjustment to Long-Run Equilibrium: Price at E 1’ is above P e  SRAS shifts up

10. Copyright © 2002 Pearson Education, Inc. Slide 25-10 Short-Run Results in the Real Business Cycle Model

11. Copyright © 2002 Pearson Education, Inc. Economic Fluctuations in the United States From 1964-1969: Expansionary monetary and fiscal policies caused AD to shift right. From 1973-1975: A supply shock resulted in SRAS shifting up and to the left. 1990-1991: A credit crunch, shifting AD to the left, which resulted in SRAS shifting down and to the right.

12. Copyright © 2002 Pearson Education, Inc. Slide 25-12 Output Growth and Inflation, 1960- 2000