ISK - Aggregate Demand, Aggregate Supply

CHAPTER
Aggregate Demand,
Aggregate Supply,
and Inflation
Prepared by: Fernando Quijano

and Yvonn Quijano
2004 Prentice Hall Business Publishing Principles of Economics, 7/e Karl Case, Ray Fair
CHAPTER 13: Aggregate Demand, Aggregate Supply, and Infation
The Aggregate Demand Curve
Aggregate demand
is the total demand for
goods and services in
the economy.
Deriving the Aggregate Demand Curve
To derive the aggregate demand

curve, we examine what happens to
aggregate output (income) (Y) when
the price level (P) changes,
assuming no changes in government
spending (G), net taxes (T), or the
monetary policy variable (Ms).
The Impact of an Increase in the Price Level on the

Economy Assuming No Changes in G, T, and Ms
P M d
r I AE Y
The aggregate
demand (AD) curve
is a curve that shows
the negative
relationship between
aggregate output
(income) and the
price level.
Other Reasons for a Downward-
Sloping Aggregate Demand Curve
The consumption link: The

decrease in consumption
brought about by an increase
in the interest rate contributes
to the overall decrease in
output.
Other Reasons for a Downward-
Sloping Aggregate Demand Curve
The real wealth effect, is the

change in consumption
brought about by a change in
real wealth that results from a
change in the price level.
Aggregate Expenditure
and Aggregate Demand
At every point along the

aggregate demand curve, the
aggregate quantity of output
demanded is exactly equal to
planned aggregate
expenditure.
Y=C+I+G
equilibrium condition
Shifts of the Aggregate Demand Curve
Factors That Shift the Aggregate Demand Curve

Expansionary monetary policy Contractionary monetary policy
Ms AD curve shifts to the right Ms AD curve shifts to the left
Expansionary fiscal policy Contractionary fiscal policy

G AD curve shifts to the right G AD curve shifts to the left
T AD curve shifts to the right T AD curve shifts to the left
Shifts of the Aggregate Demand Curve
An increase in the
quantity of money
supplied at a given
price level shifts the
aggregate demand
curve to the right.
The Aggregate Supply Curve
Aggregate supply is the

total supply of all goods
and services in the
economy.
The Aggregate Supply Curve
The aggregate supply (AS)

curve is a graph that shows
the relationship between the
aggregate quantity of output
supplied by all firms in an
economy and the overall price
level.
Aggregate Supply in the Short Run
In the short run, the

aggregate supply
curve (the price/output
response curve) has a
positive slope.
Aggregate Supply in the Short Run
At low levels of
aggregate output, the
curve is fairly flat. As
the economy
approaches capacity,
the curve becomes
nearly vertical. At
capacity, the curve is
vertical.
Output Levels and
Price/Output Responses
When the economy is operating at

low levels of output, an increase in
aggregate demand is likely to result
in an increase in output with little or
no increase in the overall price level.
As the economy approaches

maximum capacity, firms respond to
further increases in demand only by
raising prices.
Shifts of the Short-Run
Aggregate Supply Curve
A cost shock, or supply shock, is a

change in costs that shifts the aggregate
supply (AS) curve.
Shifts of the Short-Run

Factors That Shift the Aggregate Supply Curve
Shifts to the Right Shifts to the Left
Increases in Aggregate Supply Decreases in Aggregate Supply
Lower costs Higher costs
lower input prices higher input prices
lower wage rates higher wage rates
Economic growth Stagnation
more capital capital deterioration
more labor
technological change
Public policy Public policy
supply-side policies waste and inefficiency
tax cuts over-regulation
deregulation
Good weather Bad weather, natural
disasters, destruction
from wars
The Equilibrium Price Level
The equilibrium price

level is the point at
which the aggregate
demand and aggregate
supply curves intersect.
Aggregate Demand, Aggregate
Supply, and Monetary and Fiscal Policy
AD can shift to the right for

a number of reasons,
including an increase in the
money supply, a tax cut, or
an increase in government
spending.
Expansionary policy works
well when the economy is on
the flat portion of the AS
curve, causing little change
in P relative to the output
increase.
Aggregate Demand, Aggregate
Supply, and Monetary and Fiscal Policy
On the steep portion of the

AS curve, expansionary
policy does not work well.
The multiplier is close to
zero.
When the economy is
operating near full capacity,
an increase in AD will result
in an increase in the price
level with little increase in
output.
The Long-Run
Y0 represents the level

of output that can be
sustained in the long
run without inflation. It
is also called potential
output or potential
GDP.
Long-Run Aggregate
Supply and Policy Effects
If the AS curve is vertical in

the long run, neither
monetary policy nor fiscal
policy has any effect on
aggregate output.
In the long run, the
multiplier effect of a change
in government spending or
taxes on aggregate output
is zero.

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CHAPTER

Prepared by: Fernando Quijano

The Aggregate Demand Curve

Deriving the Aggregate Demand Curve

To derive the aggregate demand

Deriving the Aggregate Demand Curve

The Impact of an Increase in the Price Level on the

Deriving the Aggregate Demand Curve

Sloping Aggregate Demand Curve

The consumption link: The

Sloping Aggregate Demand Curve

The real wealth effect, is the

and Aggregate Demand

At every point along the

Shifts of the Aggregate Demand Curve

Factors That Shift the Aggregate Demand Curve

Expansionary fiscal policy Contractionary fiscal policy

Shifts of the Aggregate Demand Curve

The Aggregate Supply Curve

Aggregate supply is the

The Aggregate Supply Curve

The aggregate supply (AS)

Aggregate Supply in the Short Run

In the short run, the

Aggregate Supply in the Short Run

When the economy is operating at

As the economy approaches

Aggregate Supply Curve

A cost shock, or supply shock, is a

Aggregate Supply Curve

The Equilibrium Price Level

The equilibrium price

Supply, and Monetary and Fiscal Policy

AD can shift to the right for

Supply, and Monetary and Fiscal Policy

On the steep portion of the

Aggregate Supply Curve

Y0 represents the level

Supply and Policy Effects

If the AS curve is vertical in

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