1. Ch 10.Aggregate Demand and Aggregate Supply

2. Aggregate Demand-Aggregate Supply model (AD-AS model). Enables us to analyze changes in real GDP and the price level simultaneously. Provides insights on inflation, recession, unemployment, and economic growth.

3. A.Aggregate Demand – schedule or graph that shows the amounts of real output that buyers collectively desire to purchase at each possible price level. -- Aggregate Demand = all demand together.

4. The aggregate demand curve: downsloping indicates an inverse (negative) relationship between the price level and the amount of real output purchased. Also downsloping due to real wealth balance effect (how we feel about market), foreign trade effect (  P =  sales), and interest rate effect. Real domestic output, GDP AS D 0

5. Change in Aggregate Demand A change in the determinants of AD will SHIFT the AD curve. Right shift from AD1 to AD2 shows an increase in AD. Left shift from AD1 to AD3 shows a decrease. AD 3

6. Changes in Aggregate Demand Real Domestic Output, GDP Price Level AD 1 Increase in Aggregate Demand Changes in Aggregate Demand Curve AD 3 AD 2 Decrease in Aggregate Demand

7. B.Aggregate Supply – schedule or graph showing the level of real output that firms will produce at each possible price level. -- AS = supply of everything in our economy (U.S. GDP). -- Sticky Wages = labor contracts stuck at a certain level.

8. Aggregate Supply

9. 1.Aggregate Supply in the Long- Run (AS LR ) – vertical at full- employment level of real GDP (Q f ). -- Long run – In Microeconomics, a period of time long enough to enable producers of a product to change the quantities of all the resources they employ. 2003

10. 2.AS in the short-run (AS SR ) Price Level PLPL Q Aggregate Supply (short-run) QfQf Real domestic output, GDP Upsloping AS curve indicates a direct (or positive) relationship between the price level and the amount of real output that Firms will offer for sale.  Price =  real output.  Price =  real output. -- Short-run – In Microeconomics, a period in time in which producers are able to change the quantities of some, but not all of the resources they employ. -- If price-level rises, output increases, and profits increase because wages are fixed. -- Wages are fixed and sticky because of contracts, unawareness.

12. Changes in Aggregate Supply Understanding Productivity Productivity Total Output Total Inputs = Total Output Total Inputs == 10 5 2

13. -- Aka aggregate supply shifters. -- Change in Aggregate Supply Which is a decrease and which is an increase? 3.Determinants of AS

14. Changes in Aggregate Supply Real Domestic Output, GDP Price Level AS 1 Increase in Aggregate Supply Changes in Aggregate Supply Curve AS 3 AS 2 Decrease in Aggregate Supply

15. (a) shows decreases & increases in price level. (b) shows decreases & increases in aggregate supply.

16. C.Equilibrium – intersection of the AS & AD curves. -- Equilibrium price level and equilibrium real output = intersection. -- AS & AD jointly establish the price level and level of real GDP.

17. AD/AS Model AS: Factors of Productions (land, labor, capital, & entrepreneurial); can also include business tax & business regulation. AD: Consumer expenditures, bus. investment, gov’t expend. & net exports. The “I” in AD is business investment on demand side because the market demands payment. P L Q PePe 0 QeQe AS (Factors of Production) AD (C + I + G + X n ) shifting shifts

18. Equilibrium and Changes in Equilibrium Real Output Demanded (Billions) Price Level (Index Number) Real Output Supplied (Billions) $506 508 510 512 514 108 104 100 96 92 $513 512 510 507 502 Tabular View… Equilibrium Price Level and Equilibrium Price Level

19. Equilibrium and Changes in Equilibrium Real Domestic Output, GDP (Billions of Dollars) Price Level 100 92 502510514 a b AD AS Equilibrium

20. D.Increases in AD: Demand-Pull Inflation – price level is being pulled up by increase in AD. In the short-run Prices  Real GDP  QfQf Q1Q1

21. Equilibrium and Changes in Equilibrium Real Domestic Output, GDP Price Level AD AS P1P1 P2P2 Q2Q2 Q1Q1 QfQf AD 1 Increase in Aggregate Demand Demand-Pull Inflation

22. -- AS = Factors of Productions (land, labor, capital, & entrepreneurial); can also include business tax & business regulation. -- AD = C + I + G + X n. -- A decrease in aggregate demand that causes a recession. -- A negative GDP gap of Q 1 minus Q f results. Q1Q1 QfQf a b P1P1 E.Decrease in AD: recession & cyclical unemploy- ment.

23. Equilibrium and Changes in Equilibrium Real Domestic Output, GDP Price Level AD 1 AS P1P1 P2P2 Q1Q1 Q2Q2 QfQf AD 2 Decrease in Aggregate Demand Creates a Recession a c b

24. “Cut in gov’t spending” Q 2 Q Q P2P2 -- AD = C + I + G + X n -- AS = Factors of Production

25. “During a Recession” LRAS PLPL O Q AS AD 1 AD 2 P e  Q e  Unem 

26. F.Decrease in AS: Cost-push Inflation Real domestic output, GDP Q1 Qf AS 2 AS 1 P2P1P2P1 Price Level Q a b -- A decrease in AS that causes cost-push inflation. Cost-Push Inflation: Supply shock causes increase in price level, Govt has a policy dilemma, either higher price level or lower economic output.

27. Equilibrium and Changes in Equilibrium Real Domestic Output, GDP Price Level AD AS P1P1 P2P2 Q1Q1 QfQf Decrease in Aggregate Supply Cost-Push Inflation AS 1 a b

28. PLPL O Q AD AS 2 Q  P L  Unem  Increase in productivity, but not in wages (sticky wages?!?) 

29. “Decrease in Int’l value of Dollar” PLPL O Q AS AD 1 AD 2 P L  Q L  Unem  Q1Q1 Q2Q2 P L1 P L2  

30. G.Increase in AS: full employment w/ price-level stability. AD 1 AD 2 Price Level Real domestic output, GDP Q PLPL O AS 1 AS 2 Q1 Q2 Q3 a b c P3 P2 P1 -- Growth, full-employment, and relative price stability.

31. Equilibrium and Changes in Equilibrium Real Domestic Output, GDP Price Level AD 1 AS 2 P1P1 P2P2 Q2Q2 Q1Q1 Increases in Aggregate Supply – Full-Employment With Price-Level Stability AS 1 b AD 2 c P3P3 Q3Q3 a

32. What’s happening here?

33. A significant decline in aggregate demand that causes a recession, An excessive increase in aggregate demand can cause demand-pull inflation.