AGGREGATE DEMAND (AD)

AD is the total demand in the economy.

AD = C + I + G + (X − M)
Movements in AD
 When initial equilibrium is at lower output levels (high spare capacity):
if demand increases from AD1 to AD2, then this should give significant growth(Y1
to Y2) - with reduced unemployment - but without significant increases in inflation
(P1 to P2)

 When initial equilibrium is at higher output levels (low spare capacity):

attempts to move AD from AD3 to AD4 will result in a smaller impact on
unemployment and output (Y3 to Y4) but a much larger increase in inflation
(P3 to P4)

 The impact of moving AD thus depends on where you are on the AS curve

 If a government is deciding whether to, for example, increase spending (and

therefore AD) to stimulate the economy it should only do so if there is enough spare
capacity to accommodate the growth
Increases in exports due to
rising competitiveness.
 AGGREGATE SUPPLY (AS)
 The AS in an economy refers to the willingness and ability of producers in an
economy, largely the business sector, to produce and offer for sale, goods
and services.
 The economy might suffer from supply-side shocks which reduce the ability
or willingness of productive businesses in the economy to produce and sell
goods and services.
Such supply-side
shocks might arise
from:
 a major rise in
energy and/or raw
material prices
such as the oil
price rises
 a major rise in
labour costs;
 a significant fall in
productivity in
businesses due to
major
technological
problems
Such shifts to the right in the aggregate supply curve might arise from:
• favourable developments in the economy reducing costs such as falling energy
and raw material prices or big productivity improvements from technological
change;
• deliberate government supply-side policies designed to shift the AS curve to
the right such as privatisation, business tax reductions or labour market reforms.
Movements in AS
 If supply shifts to the left from AS1 to AS2, then this would result in higher
prices,lower output and higher unemployment (stagflation).

 Could result from a supply side “shock” – e.g. a sudden increase in oil
prices

 If supply shifts to the right from AS1 to AS3, then this will result in higher
output, lower unemployment and lower prices.

 This could be due to, say, a fall in oil prices, or to deliberate “supply side”
government policies – e.g. labour market reforms