Macroeconomic Equilibrium: Aggregate Demand and Supply

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Macroeconomic EquilibriumAggregate Demand and
Supply
Fall 2006, Chapter 12
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Why the Aggregate Demand Curve Slopes Downward

• Aggregate demand (AD) is the economy-wide demand
  for goods and services.
• Like the market demand curve, the aggregate
  demand curve slopes downward, but for different
  reasons.
• The reasons for its downward slope are
  price-level effects
• Wealth Effect (Real Wealth/Real Balances)
• Interest Rate Effect
• International Trade Effect (Substitution)

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The Aggregate Demand Curve
Note that changes in prices result in changes in
the quantity demand (or Real GDP)
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Factors that Affect AD
AD C I G Xn

• Consumption
• Income
• Wealth
• Expectations
• Demographics
• Taxes
• Investment
• Interest Rates
• Technology
• Cost of Capital Goods
• Capacity Utilization

• Government Spending
• Net Exports
• Domestic Foreign Income
• Domestic Foreign Prices
• Exchanges Rates
• Government Policy

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Shifting the Aggregate Demand Curve
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Short-Run Aggregate Supply

• A schedule showing level of real domestic output
  available at each possible price level.
• Short-run AS slopes upward because an increase in
  the price level (while production costs and
  capital are held constant on the short-run),
  means higher profit marginsfirms will want to
  produce more.

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The Shape of the Short-Run Aggregate Supply Curve
(SRAS)
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The Shape of Long-run AS (LRAS)

• Resource costs are NOT fixed.
• As prices rises, workers will want higher wages
  and will eventually get them.
• The amount of capital is not fixedfirms can
  build new plants and buy new equipment over the
  long-run.
• In the long-run, AS is set by the production
  possibilities curvethe capacity of the economy,
  and is not affected by prices, hence is vertical.

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The Shape of the Long-Run Aggregate Supply Curve
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Determinants of Aggregate Supply

• Resource Prices
• Supply Shocks
• Technology
• Expectations

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Shifting the Long-Run Aggregate Supply Curve
Growth occurs as the labor force and the capital
stock grow, as technological innovation improves
production efficiency.
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Equilibrium Real output (GDP) and the price level

• Equilibrium price and quantity are found where
  the AD, SRAS, LRAS supply curves intersect
• Graph

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Inflationary Recessionary Gaps

• Inflationary Gap illustrated
• Recessionary Gap illustrated
• Self-Correcting Adjustments for Gaps