1. 1 Figure 1a: Potential and Actual Real GDP, 1960-2001 Actual and Potential Real GDP (Billions of 1996 Dollars) 2,000 3,000 4,000 5,000 6,000 7,000 8,000 9,000 1960196519701975198019851990199520002003 The orange line shows full- employment or potential output. The green line shows actual output. During recessions, output declines. During expansions, output rises—sometimes rapidly.

2. 2 Figure 1: The Two-Way Relationship Between Output and the Price Level Price Level Real GDP Aggregate Demand Curve Aggregate Supply Curve

3. 3 Figure 2a: Deriving the Aggregate Demand Curve (a) E H 500 Money ($ Billions) Interest Rate 6% 9% MsMs As the price level rises, money demand increases and interest rate rises.

4. 4 Figure 2b/c: Deriving the Aggregate Demand Curve (b) (c) The rise in the interest rate causes real GDP to fall. Real GDP ($ Trillions) Aggregate Expenditure ($ Trillions) 610 E AE r = 6% AE r = 9% H 140 100 Price Level H AD E On the AD curve, a higher price level is associated with a lower real GDP. 106 Real GDP ($ Trillions)

5. 5 Figure 3: A Spending Shock Shifts the AD Curve (a)(b) H 1013.5 E AE 1 AE 2 At any given price level, an increase in government purchases shifts the AE line upward, raising real GDP. Real Aggregate Expenditure ($ Trillions) Real GDP ($ Trillions) 100 1013.5 AD 1 AD 2 E H Since real GDP is higher at the given price level, the AD curve shifts rightward. Real GDP ($ Trillions) Price Level

6. 6 Figure 4a: Effects of Key Changes on the Aggregate Demand Curve (a) Real GDP Price Level P3P3 Q3Q3 Q1Q1 Q2Q2 AD P1P1 P2P2 Price level ↑ moves us leftward along the AD curve Price level ↓ moves us rightward along the AD curve

7. 7 Figure 4b: Effects of Key Changes on the Aggregate Demand Curve Entire AD curve shifts rightward if: a, IP, G, or NX increases Net taxes decrease The money supply increases AD 2 AD 1 (b) Real GDP Price Level

8. 8 Figure 4c: Effects of Key Changes on the Aggregate Demand Curve AD 2 decreases Entire AD curve shifts leftward if: a, IP, G, or NX decreases Net taxes increase The money supply decreases (c) Real GDP Price Level AD 1

9. 9 Figure 5: The Aggregate Supply Curve Price Level Real GDP ($ Trillions) 130 100 80 C AS 13.5106 A B Starting at point A, an increase in output raises unit costs. Firms raise prices, and the overall price level rises. Starting at point A, a decrease in output lowers unit costs. Firms cut prices, and the overall price level falls.

10. 10 Movements Along the AS Curve  When a change in output causes price level to change, we move along economy’s AS curve What happens in economy as we make such a move? As we move upward along AS curve, we can represent what happens as follows

11. 11 Figure 6: Shifts of the Aggregate Supply Curve Price Level Real GDP ($ Trillions) 100 AS 1 A When unit costs rise at any given real GDP, the AS curve shifts upward–e.g., an increase in world oil prices or bad weather for farm production. 140 10 AS 2 L

12. 12 Figure 7a: Effects of Key Changes on the Aggregate Supply Curve (a) Real GDP Price Level P3P3 Q2Q2 Q1Q1 Q3Q3 P1P1 P2P2 AS Real GDP ↑ moves us rightward along the AS curve Real GDP ↓ moves us leftward along the AS curve

13. 13 Figure 7b: Effects of Key Changes on the Aggregate Supply Curve Real GDP Price Level (b) AS 1 AS 2 Entire AS curve shifts upward if unit costs ↑ for any reason besides an increase in real GDP

14. 14 Figure 7c: Effects of Key Changes on the Aggregate Supply Curve Real GDP Price Level (c) AS 1 AS 2 Entire AS curve shifts downward if unit costs ↓ for any reason besides an decrease in real GDP

15. 15 Figure 8: Short-Run Macroeconomic Equilibrium Price Level Real GDP ($ Trillions) 140 100 AS 10614 E B AD F

16. 16 Figure 9: The Effect of a Demand Shock Price Level Real GDP($ Trillions) 100 130 AS 10 12.5 13.5 E J H AD 1 AD 2 115

17. 17 An Increase in Government Purchases  Can summarize impact of price-level changes When government purchases increase, horizontal shift of AD curve measures how much real GDP would increase if price level remained constant  But because price level rises, real GDP rises by less than horizontal shift in AD curve

18. 18 An Decrease in Government Purchases

19. 19 An Increase in the Money Supply  Although monetary policy stimulates economy through a different channel than fiscal policy Once we arrive at AD and AS diagram, two look very much alike Can represent situation as follows

20. 20 Figure 10: The Long-Run Adjustment Process Price Level Real GDP P2P2 P3P3 P4P4 P1P1 Y FE Y3Y3 Y2Y2 H E AS 2 AS 1 AD 2 AD 1 J K

21. 21 Demand Shocks: Adjusting to the Long Run  For a positive demand shock that shifts AD curve rightward, self-correcting mechanism works like this

22. 22 Figure 11: Long-Run Adjustment After A Negative Demand Shock Price Level Real GDP P2P2 AS 1 P1P1 P3P3 Y FE Y2Y2 AS 2 AD 2 AD 1 E M N