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Chapter 24. Aggregate Demand and Aggregate Supply. The Aggregate Demand Curve. When price level rises, money demand curve shifts rightward. Consequently, interest rate is higher, given fixed money supply. Then, aggregate expenditure decreases (AE line shifts downward).

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Chapter 24
Chapter 24

Aggregate Demand and Aggregate Supply


The aggregate demand curve
The Aggregate Demand Curve

  • When price level rises, money demand curve shifts rightward.

  • Consequently, interest rate is higher, given fixed money supply.

  • Then, aggregate expenditure decreases (AE line shifts downward).

  • As a result, the equilibrium GDP becomes lower.

    So,

    a rise in price level causes a decrease in equilibrium GDP.

    The aggregate demand curve shows the negative relationship between price levels and equilibrium real GDP.



Understanding the ad curve
Understanding the AD Curve

  • Each point on the AD curve represents a short-run equilibrium in economy

  • The AD curve is different from a demand curve for one particular product


Movements of the ad curve
Movements of the AD Curve

  • Moving along the AD curve whenever price level changes.

  • When anything other than price level cause equilibrium GDP to change, the AD curve shifts.

    • Government purchasing

    • Taxes

    • Autonomous consumption spending

    • Investment spending

    • Net exports

    • Money supply

    • Expectations



Costs and prices
Costs and Prices

  • To understand how macroeconomic events affect the price level, we assume

    • A firm sets price of its products as a markup over cost per unit

    • So, in the short-run, price level rises when there is an economy-wide increase in unit costs

      • Labor costs

      • Costs of natural resources

  • How an increase in output level raises the price level?

    • As output increases, demand for inputs rises.

    • As unit cost increases, price level ( assumed as a markup over unit cost) rises.



Movements of the as curve
Movements of the AS Curve

  • When price level changes due to a change in real GDP, the change happens along the AS curve

  • When the change of price level is caused by any factor other than real GDP, the AS curve shifts

    • Oil prices

    • Weather

    • Technological change

    • Nominal wage


Figure 4 shifts of the aggregate supply curve

AS

2

Price

140

L

Level

AS

1

100

A

10

Real GDP

($ Trillions)

Figure 4: Shifts of the Aggregate Supply Curve



Figure 6 the effect of a demand shock

Price

AS

Level

130

H

J

100

E

AD

2

AD

1

12

13.5

10

Real GDP

($ Trillions)

Figure 6: The Effect of a Demand Shock


An increase in government purchases
An Increase in Government Purchases

  • When G , AD curve shifts rightward. As a result, real GDP , given price level is fixed

  • However, when real GDP , unit cost , so price level

  • Furthermore, as price level , Md and interest rate , which causes aggregate expenditure to decrease

  • In the end, real GDP increases by less than horizontal shift in AD curve


An increase in the money supply
An Increase in the Money Supply

  • Can you demonstrate how an increase in the money supply affects the real equilibrium GDP?


Demand shocks
Demand Shocks

  • A positive demand shock—shifts AD curve rightward

    • Increases both real GDP and price level in short-run

  • A negative demand shock—shifts AD curve leftward

    • Reduces both real GDP and price level in short-run


Examples
Examples

  • The Great Depression 1929 – 1933

    • Negative demand shocks

  • Oil Crisis 1973 (began on October 17)

    • Negative supply shocks


Demand shocks adjusting to the long run
Demand Shocks: Adjusting to the Long-Run

  • In short-run, wage rate is treated as given.

  • But in long-run, wage rate can change.

    • When output is above full employment, wage rate will rise, shifting AS curve upward

    • When output is below full employment, wage rate will fall, shifting AS curve downward


Figure 7 the long run adjustment process after a positive demand shock

AS

2

Price

Long-Run AS Curve

Level

P

K

4

AS

1

J

P

3

P

H

2

P

1

E

AD

2

AD

Y

Y

1

3

2

Y

Real GDP

FE

Figure 7: The Long-Run Adjustment Process After A Positive Demand Shock




More examples
More examples

  • 1990-91 recession

    • Oil supplies and price of oil

  • 2001 recession

    • Money supply and interest rate


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