Chapter 4

Aggregate demand and supply

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 Aggregate demand

• The total quantity of output demanded at alternative price

levels in a given time period, ceteris paribus. Economists use
the term "aggregate demand” to refer to the collective
behaviors of all buyers in the market place.

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 Aggregate demand

•Specially, aggregate demand refers to the various quantities

of output that all market participants are willing and able to buy
at alternative price levels in a given period. The view here
encompasses the collective demand for all goods and services,
rather than the demand for any single good.

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 Aggregate demand

•With their income in hand, people then enter the product

market. If goods and services are cheap, people will be able to
buy more with their given income. High price will limit both the
ability and willingness to purchase goods and services. Note that
we are here talking about average price level not the price of any
single good.

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 Aggregate demand
• Aggregate demand refers to the various quantities of output
that all market participants are willing and able to buy at
alternative price levels in a given period.

Prices levels are measured on the

vertical axis.
The various quantities of output
(Real GDP) that might be
purchased are depicted on the
horizontal axis.

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 Aggregate demand

• The aggregate demand curve illustrates how the volume of

purchases varies with average price. The downward slope of the
aggregate demand curve suggests that with a given (constant) level
of income, people will buy more goods and services at lower prices.
The curve doesn't tell which goods and services people will buy; it is
simply indicates the total volume (quantity) of their intended
purchases.

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 Aggregate demand

A downward-sloping demand curve requires a distinctly macro

explanation. That explanation includes three separate phenomena:
• Real balances effect: The primary explanation for the downward
slope of the aggregate demand curve is that cheaper prices make dollars
more valuable.
When their real incomes and wealth increase because of a decline
in the price level, consumers respond by buying more goods and
services. They end up saving less of their incomes an spending more.
This causes the aggregate demand curve to slope downward to the right.

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 Aggregate demand

• Foreign trade effect: The downward slope of the aggregate

demand curve is reinforced by changes in imports and exports.
When Myanmar- made products become cheaper, Myanmar
consumers will buy fewer imports and more domestic output.
Foreigners will also step up their purchases of the Myanmar-
made goods when prices are falling in Myanmar.

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 Aggregate demand

•Interest-rate effect: Changes in the price level also affect the

amount of money people need to borrow; and so tend to affect
interest rates. At lower price levels, consumer borrowing needs
are smaller.
The combined forces of the real-balances, foreign-trade,
and interest-rate effects give the aggregate demand curve its
downward slope. People buy a larger volume of output when the
price level falls (ceteris paribus).

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 Aggregate Supply
• The total quantity supplied of output producers are willing and
able to supply at alternative price levels in a given time
period,

While lower price levels tend to

increase the volume of output
demanded, they have the opposite
effect on the aggregate quantity
supplied.

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 Aggregate Supply

•Profit Margins: If the price level falls, producers as a group are

being squeezed. In the short run, producers are saddled with some
relatively constant costs like rent, interest payments, negotiated
wages and inputs already contracted for. If output prices fall,
producers will be hard-pressed to pay these costs, much less earn a
profit. Their response will be to reduce the rate of output.

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 Aggregate Supply

•Rising output price have the opposite effect. Because many costs are
relatively constant in the short run, higher prices for goods and
services tend to widen profit margins. As profit margin widen,
producers will want to produce and sell more goods. Thus, we expect
the rate output to increase when the price level rises. This expectation
is reflected in the upward slope of the aggregate supply curve in
Figure.

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 Aggregate Supply

•Aggregate supply reflects the various quantities of real

output that firms are willing and able to produce at alternative
price level, in a given time period.

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 Aggregate Supply
• Cost: The upward slope of the aggregate supply curve is also
explained by rising costs. To increase the rate of output,
producers must acquire more resources (eg. Labor) and use
existing plant and equipment more intensively.
• Cost pressures tend to intensify as capacity is approached. If
there is a lot of excess capacity, output can be increased with
little cost pressure.

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 Macro Equilibrium
Macro equilibrium is the combination of price level and
real output that is compatible with both aggregate demand
and aggregate supply.
In Figure, Instead of
describing the behavior of
buyers and sellers in a
single market, aggregate
supply and demand curves
summarize the market
activity of het whole
(macro) economy.

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 Macro Equilibrium

•The aggregate demand and supply curves intersect at only one point
(E). At that point, the price level (PE) and output (QE) combination is
compatible with both buyers' and sellers' intention.
•The economy will gravitate to those equilibrium price (P E) and

output (QE) levels. We call this situation macro equilibrium-the unique

combination of price level and output that is compatible with both buyers'
and sellers' intention.

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 Macro Equilibrium
• At any other price level, the behavior of buyers and sellers is
incompatibles. Suppose that the price level is P1, People would

want to buy only the quantity D1 at the higher price level P1. In

contract, business firms would want to sell a larger quantity S1.

This is a disequilibrium situation. Accordingly, a lot of goods will
remain unsold at price level P1.

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 Macro Equilibrium
• To sell these goods, producers will have to reduce their prices.
As prices drop, producers will decrease the volume of goods sent to
market. At the same time, the quantities that consumers seek will
increase. This adjustment process will continue until point E is
reached and the quantities demanded and supplied are equal. At that
point, the lower price level PE will prevail. The same kind of
adjustment process would occur if a lower level first existed.

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 Macro Failure
Undesirability: The price-output relationship at equilibrium may not
satisfy macroeconomic goals.

If full-employment output is
QF that is society's full-
employment goals, at the
equilibrium point E in figure
The short fall in equilibrium
output implies that the economy
will be burdened with cyclical Full employment is
unemployment. attained only if we produce
at QF. 19
 Macro Failure
•Suppose that P* represents the most desired price level. In
figure, the equilibrium price level PE exceeds P*. If a market
behavior determines prices, the price level rises above the desired
level. The resulting increase in average prices is what we call
inflation.

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 Macro Failure
•Instability: Even if the designated macro equilibrium is optimal, it may be
displaced by macro disturbances. Suppose that the macro equilibrium
yielded the optimal levels of employment and prices (see figure 4.4).
However, this equilibrium doesn't ensure because the aggregate demand and
supply curve are not necessarily permanent. They can shift and they will,
whenever the behaviors of buyers and sellers change.

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 Demand shift
The aggregate demand curve might shift, for example changed many items.
•A stock market
•Higher taxes
Figure 4.4b Demand Shift
•Higher interest ,etc. Price level
(average price)
AS1

P* E
H
P2 AD1

AD2
Q2 QF
0 Real Output (quantity per year)
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 Supply shift
External forces may also shift aggregate supply.
•Rising price level.
•Higher business taxes
•increase the supply of labor

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Thank you very much.

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