1. http://www.bized.ac.uk Copyright 2005 – Biz/ed Aggregate Demand and Supply

2. http://www.bized.ac.uk Copyright 2005 – Biz/ed Aggregate Demand and Supply

3. http://www.bized.ac.uk Copyright 2005 – Biz/ed Aggregate Demand (AD)

4. http://www.bized.ac.uk Copyright 2005 – Biz/ed Aggregate Demand The sum of all expenditure in the economy over a period of time Macro concept – WHOLE economy Formula: AD = C+I+G+(X-M) –C= Consumption Spending –I = Investment Spending –G = Government Spending –(X-M) = difference between spending on imports and receipts from exports (Balance of Payments)

5. http://www.bized.ac.uk Copyright 2005 – Biz/ed Aggregate Demand Curve Shows the overall level of spending at different price levels Note – Inflation used for the vertical axis – follows from new thinking on the derivation of AD curves from the likes of David Romer @ University of California – Assumes Central Banks do not target the money supply but short term interest rates

6. http://www.bized.ac.uk Copyright 2005 – Biz/ed Aggregate Demand Curve Why does it slope down from left to right? –Assume Bank of England sets short term interest rates –Assume a rise in the price level will be met by a rise in interest rates –Any increase in interest rates will raise the cost of borrowing: Consumption spending will fall Investment will fall International competitiveness will decrease – exports fall, imports rise Therefore – a rise in the price level leads to lower levels of aggregate demand

7. http://www.bized.ac.uk Copyright 2005 – Biz/ed Aggregate Demand Curve The AD diagram: Inflation on the vertical axis – assume an initial ‘target rate’ of 2.0% (as measured by the HICP or CPI) Real GDP or Real National Income or Real Output on the vertical axis (shown by the initial Y)

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27. http://www.bized.ac.uk Copyright 2005 – Biz/ed Putting AD and AS together Inflation Real National Income AS Yf AD 2.0% Y1 AD1 Y2 2.5% AD2 3.5% Further increases in AD would lead to successively smaller increases in growth and employment at the cost of ever higher inflation. Y3

28. http://www.bized.ac.uk Copyright 2005 – Biz/ed Sustained Growth Inflation Real National Income AD AS 2.0% Y1 AS1 Y2 AD2 Sustained growth (not to be confused with sustainable economic growth) occurs when AS and AD rise at similar rates – national income can rise without effects on inflation