AGGREGATE

DEMAND AND
SUPPLY
Nguyễn Việt Hưng
OBJECTIVES
 Economic fluctuations
 Aggregate demand
 Aggregate supply
• Long-run
• Short-run
 Causesof economic
fluctuation
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ECONOMIC FLUCTUATIONS

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ECONOMIC FLUCTUATIONS

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ECONOMIC FLUCTUATIONS

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ECONOMIC FLUCTUATIONS
A sequence of economic activity typically
characterized by recession, fiscal recovery,
growth, and fiscal decline

Fluctuations in the economy are often

called the business cycle (growth, slow
down, recession, recovery)

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 ><
expansion

Recession a period of declining incomes and rising

unemployment
Expansion an increase in the level of economic activity,
and of goods and services available in the market place.

Depression a severe recession

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 3 KEY FACTS
ABOUT ECONOMIC FLUCTUATIONS

Fa • economic fluctuations are

ct irregular and unpredictable
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Fa • most macroeconomic
ct quantities fluctuate together
2
Fa • as output falls,
ct unemployment rises
3
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 Model of aggregate demand and aggregate supply
• the model that most economists use to explain short-run
fluctuations in economic activity around its long-run trend

Aggregate
demand curve
Short-run
AS/AD model aggregate supply
curve (SRAS)
Aggregate supply
curve
Long-run
aggregate supply
curve (LRAS)

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THE AGGREGATE DEMAND CURVE

Aggregate demand curve tells us the quantity of all goods

and services demanded in the economy at any given price
level

AD = C+I+G+(X-M)

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How does price affect aggregate demand?

Higher overall price level makes

total quantity of domestic goods
and services demanded decrease

The Wealth Effect

The Interest-Rate Effect

The International Trade Effect

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How does price affect aggregate demand?
The Wealth Effect

Pricelevel
Price levelfalls
falls Price
level

Consumersfeel
Consumers feel
P1
morewealthy
wealthy

Ag
more

g
re
ga
te
d
P2

em
an
d
Theyspend
They spendmore
more

0 Y1 Y2 Quantity of
Quantityof
Quantity ofgoods
goods output
andservices
and services
demandedrises
demanded rises

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How does price affect aggregate demand?
The Interest-Rate Effect

Price
level
Price level falls

P1

Ag
Households hold less money

g
re
ga
and lend some out

te
d
P2

em
an
d
They convert their money into
interest-bearing assets
0
Y1 Y2 Quantity of
output
Interest-rate falls

Quantity of goods
Firms want to borrow more and and services
spend more in investment goods demanded rises
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 How does price affect aggregate demand?
The International Trade Effect : 2 cases

U.S Price
level falls U.S goods Both Quantity
U.S net
relative to relatively less Americans of goods
exports
foreign price expensive and foreigners and services
rise
level (exchange- than foreign buy more demanded
rate doesn’t goods U.S goods rises
change)

Real exchange
U.S price U.S interest rate
level fall rate falls depreciates

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 Which other factors shift the Aggregate Demand
curve?

Consumption
1. Pessimistics
Investment /Optimistics
Changes Aggregate
in 2. Policies demand curve
Government Fiscal/monetary/exchange shifts
Purchases rate/trade policies

3. World
Net Exports economy

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 Shifts Arising from Consumption

Example
A tax cut makes people feel Price level

more wealthy and happy

They spend more

A B
P
Greater quantity of goods
and services demanded at
any given price level

Aggregate demand curve Y1 Y2 Quantity of

output
shifts to the right

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 RVE
LY CU
UP P
TE S
EGA
GGR
E A
TH

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THE AGGREGATE-SUPPLY CURVE

 Tells us the total quantity of goods and

services that all firms in the economy
produce and sell at any given price
level.
 Assumption:
 The amount of factors of production

(capital, technology, and labor

force) is given

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THE AGGREGATE-SUPPLY CURVE

labor

REAL GDP
capital Available (potential
technology output)

Natural resources

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THE AGGREGATE-SUPPLY CURVE
 When prices go up, firms produce more
only for a while (short-run)
 When prices go up, firms could not
produce more than the potential level
(long-run)
• Because factors of production are assumed being fixed

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 HOW THE SHORT RUN DIFFERS FROM
THE LONG RUN

Short run Long run

• a period of time in which prices • a period of time in which prices
are not flexible and information is are completely flexible and
not well-perceived. information is well-perceived

• Classical theory of money

• Keynesian theory neutrality

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IN THE LONG RUN

-The long-run aggregate supply curve

reflects the classical model of the
economy
The LRAS curve is vertical
at the potential output. That

means the price level does

not affect these long-run
determinants of real GDP.
(only in the long run)

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WHEN DOES THE LRAS CURVE SHIFT

labor

Shifts
capital arising Technological
Knowledge
from...

Natural
Resources

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 THE AGGREGATE-SUPPLY
CURVE IN THE SHORT RUN

 Why the aggregate-supply curve

slopes upward in the short run?
 The price level has positive
impact on the quantity
produced

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WHY THE AGGREGATE-SUPPLY CURVE SLOPES
UPWARD IN THE SHORT RUN?

 The Sticky-Wage Theory:

Nominal wages are slow to adjust, or are “sticky”,
in the short run.

Wages do not adjust immediately to the price

level, a lower price level makes employment and
production less profitable, which induces firms to
reduce the quantity of goods and services
supplied.

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WHY THE AGGREGATE-SUPPLY CURVE SLOPES
UPWARD IN THE SHORT RUN?

 The Misperceptions Theory:

Suppliers respond to changes in the perceived
relative prices, and this respond leads to an upward-
sloping aggregate-supply curve.

A lower general price level causes misperceptions

about relative prices, and these misperceptions
include suppliers decrease the quantity of goods
and services supplied.

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WHEN DOES SHORT-RUN AS
CURVE SHIFT?
 Change in input prices (wages and materials)
 Change in the state of technology
 Taxes, subsidies, or economic regulations
 Change in expected price level

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 TWO CAUSES OF
ECONOMIC FLUCTUATIONS

 The effects of a shift in

aggregate demand

 The effects of a shift in

aggregate supply

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 LR Aggregate supply

Price
Level

SR Aggregate Supply

B:SR equi

A: long-run
equilibrium

Aggregate Demand

0 Quantity of
Output
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 LR Aggregate supply

Price
Level

A: long-run SR Aggregate Supply

equilibrium
B:SR equi

Aggregate Demand

0 Quantity of
Output
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 DEMAND SHOCK

Price
Firms are pessimistic
Level
about the future of
the economy and
reduce investment
Aggregate
supply

Aggregate
supply
Equilibrium
price level

Aggregate
demand

0 Equilibrium Quantity of
output Output
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 SUPPLY SHOCK

Price
Level

Aggregate
supply

An increase in oil price

causes input costs of
Equilibrium firms to increase.
price level

Aggregate
demand

0 Equilibrium Quantity of
output Output
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