ASSIGNMENT ON

Review on Aggregate Demand Curve and

Aggregate Supply Curve

Submitted To
Prof. Fatima Khan
Submitted By
Abdullah Atiq
Registration No:
M1F22UBBA031
Assignment
4
Class
BBA (3rd Semester)

(A Constituent college of)

UNIVERSITY OF CENTRAL PUNJAB
Aggregate Demand Curve

The aggregate-demand curve illustrates the total quantity of all goods and services
demanded across the economy at different price levels, showing a downward slope. This
means that as the overall price level decreases, the demand for goods and services increases.
This relationship is explained through the effects of changes in the price level on
consumption (wealth effect), investment (interest-rate effect), and net exports (exchange-rate
effect). Specifically, Wealth Effect on Consumption, Interest-Rate Effect on Investment, and
Exchange-Rate Effect on Net Exports.

The aggregate-demand curve can shift due to various factors affecting consumption,
investment, government purchases, and net exports. Changes in consumer confidence,
investment opportunities, government spending, and international economic conditions can
all cause the aggregate-demand curve to shift left or right. For example, an increase in
consumer spending or government purchases shifts the curve to the right, indicating higher
demand at every price level, while an increase in taxes or pessimism about the future can
shift it to the left, indicating lower demand.

In summary, the downward slope of the aggregate-demand curve reflects the inverse
relationship between the price level and the total demand for goods and services in the
economy. Shifts in the curve are influenced by changes in consumption, investment,
government spending, and net exports, driven by policy decisions and economic conditions.

Aggregate Supply Curve

This text provides a comprehensive explanation of the aggregate-supply curve in

economics, distinguishing between the long-run and short-run perspectives. It explains why
the long-run aggregate-supply curve is vertical, highlighting that the quantity of goods and
services a nation can produce depends on its labor, capital, natural resources, and technology,
and not on the overall price level. This underscores the classical dichotomy and the principle
of monetary neutrality, where real variables (like output) are not influenced by nominal
variables (like the price level) in the long run. The document also explores factors that can
shift the long-run aggregate-supply curve, such as changes in labor supply, capital stock,
natural resources, and technological knowledge. These shifts reflect changes in the economy's
potential output or full-employment output, which is also referred to as the natural rate of
output. In contrast, the short-run aggregate-supply curve is upward sloping, indicating that
price levels can influence the quantity of goods and services supplied over short periods. The
text presents three theories to explain this phenomenon, all of which suggest that deviations
from the expected price level can cause output to temporarily diverge from its natural rate.
Overall, the document adeptly bridges the concepts of long-run economic growth and short-
run economic fluctuations, providing a foundation for understanding how economies adjust to
changes over different time horizons. It emphasizes the significance of expectations in the
short-run aggregate supply and the inherent differences in economic behavior across time
frames, making it a valuable resource for grasping fundamental macroeconomic principles.

Two Causes of Economic Fluctuations

The two basic causes of economic fluctuations, also known as economic cycles or
business cycles, are shifts in aggregate demand and shifts in aggregate supply. These shifts
can lead to short-run economic fluctuations that affect the overall output and price levels in
an economy. Here's a brief overview of each cause

1. Shifts in Aggregate Demand

Aggregate demand represents the total demand for goods and services within an
economy at a given overall price level and in a given period. It can fluctuate due to various
factors such as changes in consumer confidence, fiscal policies (government spending and
taxation), monetary policies (interest rates and money supply), and external events (such as
wars or stock market crashes). A shift to the left (decrease) in aggregate demand can lead to
lower output and higher unemployment in the short run, whereas a shift to the right (increase)
can cause higher output and lower unemployment. However, in the long run, shifts in
aggregate demand mainly affect the overall price level (inflation or deflation) without
affecting the natural rate of output.

2. Shifts in Aggregate Supply

Aggregate supply refers to the total supply of goods and services that firms in an
economy plan on selling during a specific time period. It can shift due to changes in
production costs (including wages, raw materials, and technology), labor force changes,
capital stock variations, and natural events (such as natural disasters). A leftward shift
(decrease) in aggregate supply, also known as a negative supply shock, can lead to
stagflation, a situation characterized by rising prices (inflation) and falling output (recession).
On the other hand, a rightward shift (increase) in aggregate supply can lead to higher output
and lower prices, benefiting the economy's growth without causing inflation.

These two causes interact within the economic framework to determine the overall
level of economic activity, price levels, and employment rates. Policymakers use monetary
and fiscal tools to try to mitigate the negative effects of economic fluctuations and stabilize
the economy, aiming for sustainable growth with low inflation and high employment.

Conclusion

In conclusion, understanding the dynamics of the aggregate demand and aggregate

supply curves is crucial for analyzing economic fluctuations and the overall health of an
economy. The aggregate demand curve's downward slope illustrates the inverse relationship
between the price level and total demand, affected by changes in consumption, investment,
government spending, and net exports. Meanwhile, the distinction between the short-run and
long-run aggregate supply curves highlights the temporal effects of price levels on output,
with the long-run curve being vertical due to the economy's capacity being based on
resources and technology, not price levels. Economic fluctuations arise primarily from shifts
in these curves, driven by various internal and external factors. Policymakers, therefore,
strive to manage these fluctuations through fiscal and monetary interventions, aiming to
mitigate the impacts of recessions and stabilize economic growth, keeping inflation in check
and maximizing employment. This interplay between demand and supply, short-term
adjustments, and long-term economic capacity forms the backbone of macroeconomic
analysis and policy formulation.