Chapter 18 - Student - AD - As

N.
GREGORY MANKIW
PRINCIPLES OF
ECONOMICS
Eight Edition
CHAPTER Aggregate Demand

33 and Aggregate Supply
PowerPoint Slides prepared by:
V. Andreea CHIRITESCU
Eastern Illinois University
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 1
management system for classroom use.
Economic Fluctuations, Part 1
• Economic activity
– Fluctuates from year to year
• Recession
– Economic contraction
– Period of declining real
incomes and rising “You’re fired.
unemployment Pass it on.”
• Depression
– Severe recession
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part,
except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or 2
school-approved learning management system for classroom use.
Economic Fluctuations, Part 2
Three key facts about economic fluctuations
1. Economic fluctuations are irregular and
unpredictable
• The business cycle
2. Most macroeconomic quantities fluctuate
together
• Recessions: economy-wide phenomena
3. As output falls, unemployment rises
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Figure 1A Look at Short-Run Economic Fluctuations, Part 3
This figure shows real GDP in panel (a), investment spending in panel (b), and unemployment
in panel (c) for the U.S. economy. Recessions are shown as the shaded areas. Notice that real
GDP and investment spending decline during recessions, while unemployment rises.
Short-Run Economic Fluctuations, Part 1
• Classical dichotomy
– Separation of variables into:
• Real variables
• Nominal variables
• Monetary neutrality
– Changes in the money supply
• Affect nominal variables
• Do not affect real variables
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learning management system for classroom use.
• Classical theory holds in the long-run

– Changes in money supply
• Affect prices, and other nominal variables
• Do not affect real GDP, unemployment, or
other real variables
• Short-run
– Assumption of monetary neutrality: no
longer appropriate
– Real and nominal variables are highly
intertwined
– Changes in the money supply
• Can temporarily push real GDP away from its
long-run trend
• AD-AS model
– Model of aggregate demand (AD) and
aggregate supply (AS)
– Most economists use it to explain short-
run fluctuations in economic activity
• Around its long-run trend
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for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved 8
• Aggregate-demand curve
– Shows the quantity of goods and services
– That households, firms, the government,
and customers abroad
– Want to buy at each price level
– Downward sloping
• Aggregate-supply curve
– Shows the quantity of goods and services
– That firms choose to produce and sell
– At each price level
– Upward sloping
Figure 2 Aggregate Demand and Aggregate Supply
Economists use the model of aggregate demand and aggregate supply to analyze economic
fluctuations. On the vertical axis is the overall level of prices. On the horizontal axis is the
economy’s total output of goods and services.
Output and the price level adjust to the point at which the aggregate-supply and aggregate-
demand curves intersect.
The Aggregate-Demand Curve, Part 1
Y = C + I + G + NX
• Three effects explain why AD curve
slopes downward:
– Wealth effect (C )
– Interest-rate effect (I)
– Exchange-rate effect (NX)
• Assumption: government spending (G)
– Fixed by policy
• Price level and consumption (C): the

wealth effect
– Decrease in price level
• Increase in the real value of money
• Consumers are wealthier
• Increase in consumer spending
• Increase in quantity demanded of goods and
services
• Price level and investment (I): the

interest-rate effect
– Decrease in price level
• Decrease in the interest rate
• Increase spending on investment goods
services
• Price level and net exports (NX): the

exchange-rate effect
– Decrease in U.S. price level
• Decrease in the interest rate
• U.S. dollar depreciates
• Stimulates U.S. net exports
services
• Summary: a fall in price level

– Increases quantity of goods and services
demanded
– Because:
1. Consumers are wealthier: stimulates the demand
for consumption goods
2. Interest rates fall: stimulates the demand for
investment goods
3. Currency depreciates: stimulates the demand for
net exports
• Summary: a rise in price level

– Decreases the quantity of goods and services
demanded
– Because:
1. Consumers are poorer: depress consumer
spending
2. Higher interest rates fall: depress investment
spending
3. Currency appreciates: depress net exports
Figure 3 The Aggregate-Demand Curve
A fall in the price level from P1 to P2 increases the quantity of goods and services demanded from Y1 to Y2.
There are three reasons for this negative relationship. As the price level falls, real wealth rises, interest
rates fall, and the exchange rate depreciates. These effects stimulate spending on consumption,
investment, and net exports. Increased spending on any or all of these components of output means a
larger quantity of goods and services demanded.
• The AD curve might shift:

– Changes in consumption, C
– Changes in investment, I
– Changes in government purchases, G
– Changes in net exports, NX
• Changes in consumption, C
– Events that change how much people
want to consume at a given price level
• Changes in taxes, wealth
– Increase in consumer spending
• Aggregate-demand curve: shift right
• Changes in investment, I
– Events that change how much firms want
to invest at a given price level
• Better technology
• Tax policy
• Money supply
– Increase in investment
• Changes in government purchases, G

– Policy makers – change government
spending at a given price level
• Build new roads
– Increase in government purchases
• Changes in net exports, NX

– Events that change net exports for a given
price level
• Recession in Europe
• International speculators – change in
exchange rate
– Increase in net exports
The Aggregate-Supply Curve, Part 1
• Long run aggregate-supply curve is

vertical, LRAS
– Price level does not affect the long-run
determinants of GDP:
• Supplies of labor, capital, and natural
resources
• Available technology
• Short run
– Aggregate-supply curve is upward sloping
Figure 4 The Long-Run Aggregate-Supply Curve
In the long run, the quantity of output supplied depends on the economy’s quantities of labor,
capital, and natural resources and on the technology for turning these inputs into output.
Because the quantity supplied does not depend on the overall price level, the long-run
aggregate-supply curve is vertical at the natural level of output.
• Natural level of output

– Production of goods and services
– That an economy achieves in the long run
• When unemployment is at its normal rate
– Potential output
– Full-employment output
• The LRAS curve might shift:

– Any change in natural level of output
– Changes in labor
– Changes in capital
– Changes in natural resources
– Changes in technological knowledge
• Changes in labor
– Quantity of labor – increases
• Aggregate-supply curve: shifts right
– Natural rate of unemployment – increases
• Aggregate-supply curve: shifts left
• Changes in capital
– Capital stock – increase
– Physical and human capital
• Changes in natural resources

– New discovery of natural resource
– Weather
– Availability of natural resources
• Changes in technology
– New technology, for given labor, capital
and natural resources
– International trade
– Government regulation
Long-Run Growth and Inflation
• Long run: both AD and LRAS curves shift
– Continual shifts of LRAS curve to right
• Technological progress
– AD curve shifts to right
• Monetary policy
• The Fed increases money supply over time
– Result:
• Continuing growth in output
• Continuing inflation
Figure 5 Long-Run Growth and Inflation in the Model of Aggreg
•As the economy becomes better able to produce goods and services over time, primarily
because of technological progress, the long-run aggregate-supply curve shifts to the right. At
the same time, as the Fed increases the money supply, the aggregate-demand curve also
shifts to the right. In this figure, output grows from Y1990 to Y2000 and then to Y2010, and the price
level rises from P1990 to P2000 and then to P2010. Thus, the model of aggregate demand and
aggregate supply offers a new way to describe the classical analysis of growth and inflation.
• Aggregate supply curve slopes upward in

the short-run:
– Price level affects the economy’s output
– Increase in overall level of prices in economy
• Tends to raise the quantity of goods and services
supplied
– Decrease in level of prices
• Tends to reduce quantity of goods and services
supplied
Figure 6 The Short-Run Aggregate-Supply Curve
In the short run, a fall in the price level from P1 to P2 reduces the quantity of output supplied
from Y1 to Y2. This positive relationship could be due to sticky wages, sticky prices, or
misperceptions. Over time, wages, prices, and perceptions adjust, so this positive relationship
is only temporary.
• Theories that explain why the AS curve

slopes upward in short-run:
– Sticky-wage theory
– Sticky-price theory
– Misperceptions theory
• Sticky-wage theory
– Nominal wages - slow to adjust to changing
economic conditions
• Long-term contracts: workers and firms
• Slowly changing social norms
• Notions of fairness - influence wage setting
– Nominal wages - based on expected prices
• Don’t respond immediately when actual price level –
different from what was expected
• Sticky-wage theory
– If price level < expected
• Firms – incentive to produce less output
– If price level > expected
• Firms – incentive to produce more output
• Sticky-price theory
– Prices of some goods and services
• Slow to adjust to changing economic
conditions
• Menu costs: costs to adjusting prices
• Misperceptions theory
– Changes in the overall price level
• Can temporarily mislead suppliers
– About changes in individual markets
– Changes in relative prices
• Suppliers - respond to changes in level of
prices
– Change - quantity supplied of goods and services
• The short-run AS curve might shift:

– Changes in labor, capital, natural
resources, or technological knowledge
– Expected price level increases
Causes of Economic Fluctuations, Part 1
• Assumption
– Economy begins in long-run equilibrium
• Long-run equilibrium:
– Intersection of AD and LRAS curves
• Natural level of output
• Actual price level
– Intersection of AD and short-run AS curve
• Expected price level = Actual price level
Figure 7 The Long-Run Equilibrium
The long-run equilibrium of the economy is found where the aggregate-demand curve crosses
the long-run aggregate-supply curve (point A). When the economy reaches this long-run
equilibrium, the expected price level will have adjusted to equal the actual price level. As a
result, the short-run aggregate-supply curve crosses this point as well.
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part,
except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or 42
school-approved learning management system for classroom use.
• Shift in aggregate demand

– Wave of pessimism: AD shifts left
– Short-run
• Output falls
• Price level falls
– Long-run
• Short-run aggregate-supply curve shifts right
• Output – natural level
• Price level – falls
Table 3 Four Steps for Analyzing Macroeconomic
Fluctuations
1. Decide whether the event shifts the aggregate-demand

curve or the aggregate-supply curve (or perhaps both).
2. Decide the direction in which the curve shifts.
3. Use the diagram of aggregate demand and aggregate
supply to determine the impact on output and the price
level in the short run.
4. Use the diagram of aggregate demand and aggregate
supply to analyze how the economy moves from its new
short-run equilibrium to its new long-run equilibrium.
Figure 8 A Contraction in Aggregate Demand
A fall in aggregate demand is represented with a leftward shift in the aggregate-demand curve
from AD1 to AD2. In the short run, the economy moves from point A to point B. Output falls from
Y1 to Y2, and the price level falls from P1 to P2. Over time, as the expected price level adjusts,
the short-run aggregate-supply curve shifts to the right from AS1 to AS2, and the economy
reaches point C, where the new aggregate-demand curve crosses the long-run aggregate-
supply curve. In the long run, the price level falls to P3, and output returns to its natural level,
Y1.
• Shift in aggregate supply

– Firms – increase in production costs
– Short-run - stagflation
• Output falls, price level rises
– Long-run, if AD is held constant
• Short-run AS shifts back to right
• Price level - falls
Figure 10 An Adverse Shift in Aggregate Supply
When some event increases firms’ costs, the short-run aggregate-supply curve shifts to the left
from AS1 to AS2. The economy moves from point A to point B. The result is stagflation: Output
falls from Y1 to Y2, and the price level rises from P1 to P2.
• Shift in aggregate supply

– Firms – increase in production costs
– Short-run
• Output falls
• Price level rises
– Long-run, policymakers – shift AD to right
• Price level – rises
Figure 11 Accommodating an Adverse Shift in Aggregate Supply
Faced with an adverse shift in aggregate supply from AS1 to AS2, policymakers who can
influence aggregate demand might try to shift the aggregate-demand curve to the right from
AD1 to AD2. The economy would move from point A to point C. This policy would prevent the
supply shift from reducing output in the short run, but the price level would permanently rise
from P1 to P3.
N. GREGORY MANKIW
PRINCIPLES OF
ECONOMICS
Eight Edition
CHAPTER The Influence of Monetary

34 and Fiscal Policy on
Aggregate Demand
PowerPoint Slides prepared by:
V. Andreea CHIRITESCU
Eastern Illinois University
Demand and Supply of Money, Part 1
• Money supply
– Controlled by the Fed
– Quantity of money supplied
• Fixed by Fed policy
• Doesn’t vary with interest rate
– Fed alters the money supply
• Changing the quantity of reserves in the banking
system
– Purchase and sale of government bonds in open-
market operations
• Money demand
– Money – most liquid asset
• Can be used to buy goods and services
– Interest rate – opportunity cost of holding money
– Money demand curve – downward sloping
• Increase in the interest rate
– Raises the cost of holding money
– Reduces the quantity of money demanded
• Equilibrium in the money market

– Interest rate – adjusts to balance the supply
and demand for money
– Equilibrium interest rate
– Quantity of money demanded exactly
balances the quantity of money supplied
• If interest rate > equilibrium

– Quantity of money people want to hold
• Less than quantity supplied
– People holding the surplus
• Buy interest-bearing assets
– Lowers the interest rate
– People - more willing to hold money
– Until: equilibrium
• If interest rate < equilibrium

– Quantity of money people want to hold
• More than quantity supplied
– People - increase their holdings of money
• Sell - interest-bearing assets
– Increase interest rates
– Until: equilibrium
Figure 1 Equilibrium in the Money Market
According to theory of liquidity preference, the interest rate adjusts to bring the quantity of money supplied
and the quantity of money demanded into balance. If the interest rate is above the equilibrium level (such
as at r1), the quantity of money people want to hold (M d1) is less than the quantity the Fed has created,
and this surplus of money puts downward pressure on the interest rate. Conversely, if the interest rate is
below the equilibrium level (such as at r2), the quantity of money people want to hold (Md2) is greater than
the quantity the Fed has created, and this shortage of money puts upward pressure on the interest rate.
Thus, the forces of supply and demand in the market for money push the interest rate toward the
equilibrium interest rate, at which people are content holding the quantity of money the Fed has created.
Aggregate Demand
• The downward slope of the AD curve
1. A higher price level
– Raises money demand
2. Higher money demand
– Leads to a higher interest rate
3. A higher interest rate
– Reduces the quantity of goods and services
demanded
Figure 2 The Money Market and the Slope of the
Aggregate-Demand Curve
An increase in price level from P1 to P2 shifts money-demand curve to the right, as in panel (a).
This increase in money demand causes the interest rate to rise from r1 to r2. Because the interest
rate is the cost of borrowing, the increase in the interest rate reduces the quantity of goods and
services demanded from Y1 to Y2. This negative relationship between the price level and quantity
demanded is represented with a downward-sloping aggregate-demand curve, as in panel (b).
Monetary Policy Influences AD, Part 1
• Aggregate-demand curve shifts

– Quantity of goods and services demanded
changes
– For a given price level
• Monetary policy
– Increase in money supply
– Decrease in money supply
– Shifts aggregate-demand curve
• The Fed increases the money supply

– Money-supply curve shifts right
– Interest rate falls
– At any given price level
services
– Aggregate-demand curve shifts right
Figure 3 A Monetary Injection
In panel (a), an increase in the money supply from MS1 to MS2 reduces the equilibrium interest
rate from r1 to r2. Because the interest rate is the cost of borrowing, the fall in the interest rate
raises the quantity of goods and services demanded at a given price level from Y1 to Y2. Thus, in
panel (b), the aggregate-demand curve shifts to the right from AD1 to AD2.
• The Fed decreases the money supply

– Money-supply curve shifts left
– Interest rate increases
– At any given price level
• Decrease in quantity demanded of goods and
services
– Aggregate-demand curve shifts left
• Changes in monetary policy aimed at

expanding aggregate demand
– Increasing the money supply
– Lowering the interest rate
• Changes in monetary policy aimed at
contracting aggregate demand
– Decreasing the money supply
– Raising the interest rate
Fiscal Policy Influences AD, Part 1
• Fiscal policy
– Government policymakers
– Set the level of government spending and
taxation
• Shift the aggregate demand
– Multiplier effect
– Crowding-out effect
• The multiplier effect

– Additional shifts in aggregate demand
• Result when expansionary fiscal policy
increases income
• And thereby increases consumer spending
• The multiplier effect of an increase in

government purchases by $20 billion
– Aggregate-demand curve
• Shifts right by exactly $20 billion
– Consumers respond
• Increase spending
– Aggregate-demand curve
• Shifts right again
Figure 4 The Multiplier Effect
An increase in government purchases of $20 billion can shift the aggregate-demand curve to
the right by more than $20 billion. This multiplier effect arises because increases in aggregate
income stimulate additional spending by consumers.
• Multiplier effect
– Response of consumer spending
– Response of investment
• Investment accelerator
– Higher government demand
• Higher demand for investment goods
– Positive feedback from demand to
investment
Số nhân chi tiêu - MPC
69
Using Policy for Stabilization, Part 1
• The case for active stabilization policy

– A change in aggregate-demand
• The government: use fiscal policy
• The Fed: use monetary policy
• To stabilize the economy
Using Policy for Stabilization, Part 6
• Automatic stabilizers
– Changes in fiscal policy
• That stimulate aggregate demand
• When the economy goes into a recession
– Without policymakers having to take any
deliberate action
– The tax system
– Government spending

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N.

CHAPTER Aggregate Demand

• Classical theory holds in the long-run

• Price level and consumption (C): the

• Price level and investment (I): the

• Price level and net exports (NX): the

• Summary: a fall in price level

• Summary: a rise in price level

• The AD curve might shift:

• Changes in government purchases, G

• Changes in net exports, NX

• Long run aggregate-supply curve is

• Natural level of output

• The LRAS curve might shift:

• Changes in natural resources

• Aggregate supply curve slopes upward in

• Theories that explain why the AS curve

• The short-run AS curve might shift:

• Shift in aggregate demand

1. Decide whether the event shifts the aggregate-demand

• Shift in aggregate supply

• Shift in aggregate supply

CHAPTER The Influence of Monetary

• Equilibrium in the money market

• If interest rate > equilibrium

• If interest rate < equilibrium

• Aggregate-demand curve shifts

• The Fed increases the money supply

• The Fed decreases the money supply

• Changes in monetary policy aimed at

• The multiplier effect

• The multiplier effect of an increase in

• The case for active stabilization policy

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