Chapter 7: Aggregate Demand and Aggregate Demand and ...

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Chapter 7: Aggregate Demand and Aggregate Demand and ...

Chapter 7:

Aggregate

Demand and

Aggregate Supply

Aggregate Demand

Aggregate Supply Model

• The AD-ASAS model enables us to analyze

changes in real GDP and the price level

simultaneously.

• The AD-AS model provides keen insights on

inflation, recession, unemployment, and

economic growth.

The Aggregate DemandAggregate Supply (AD-AS)

model is the macroeconomic model that uses aggregate

demand and aggregate supply to determine and explain the

price level and the level of real domestic output.

LO: 7-1

McGraw-Hill/Irwin

Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

7-2

Aggregate Demand and the

Aggregate Demand Curve

Aggregate demand

curve is a schedule that

shows the total quantity

of goods and services

demanded at different

price levels.

• There is an inverse

relationship between the

price level (as measured

by the GDP price index)

and real output

demanded (real GDP).

LO: 7-1

ice Level

Pri

Aggregate

Demand

AD

Real Domestic Output, GDP

Changes in Aggregate

Demand

Determinant: Factor(s) of Determinant: AD shifts:

Consumer wealth increases

Consumer Consumers’ real incomes rise

RIGHT

Spending Household indebtedness rises

Tax increases

LEFT

Investment

Increases in real interest rate

LEFT

Spending Higher expected returns

RIGHT

Government

Spending

Increase in government spending

RIGHT

Net export Rising national income abroad

Spending

Depreciation of the dollar

RIGHT

LO: 7-1

7-3

7-4


Shifts in the Aggregate

Demand dCurve

LO: 7-1

ce Level

Pric

Decrease in

Aggregate

Demand

Increase in

Aggregate

Demand

AD 3

Real Domestic Output, GDP

AD 1

AD 2

7-5

Aggregate Supply

Aggregate supply curve is a schedule that shows the

total quantity of goods and services supplied at different

price levels.

• The aggregate supply curve in the short run and in the

long run vary by the degree of wage adjustment

• In the immediate short run, output and input prices are

fixed, and the AS curve is horizontal

• In the short run output prices are flexible while input prices

are sticky, thus the AS curve is positively sloped

• In the long run all prices are flexible, economy is at full

employment (output is equal to potential), and the AS curve

is vertical

LO: 7-2

7-6

Immediate Short Run

Aggregate Supply

Short Run

Aggregate Supply

Pric ce Level

AS ISR

Price Leve el

Aggregate Supply

(Short Run)

Immediate Short Run

Aggregate Supply

0

Q f

7-8

Real Domestic Output, GDP

LO: 7-2

Real Domestic Output, GDP

LO: 7-2

7-7


Long Run

Aggregate Supply

Changes in Aggregate Supply

ce Level

Pric

Long Run

Aggregate

Supply

AS LR

Determinant: Factor(s) of Determinant: AS

shifts:

Input Prices Domestic resource prices rise

Prices of imported resources rise

Increased market power

LEFT

Productivity Increases in productivity RIGHT

Legal-

Institutional

Environment

Higher business taxes

More government regulation

LEFT

LO: 7-2

Real Domestic Output, GDP

7-9

LO: 7-2

7-10

Shifts in the Aggregate

Supply Curve

LO: 7-2

Pric ce Level

Decrease in

Aggregate

Supply

AS 3

AS1

Real Domestic Output, GDP

AS 2

Increase in

Aggregate

Supply

Equilibrium Price Level and

Real GDP

• Equilibrium occurs at the price level that

equalizes the amount of real output

demanded and supplied.

• The equilibrium point is the intersection

of the aggregate demand curve and

aggregate supply curve.

• This intersection determines the

equilibrium price level and equilibrium

real output.

LO: 7-3

7-11

7-12


Equilibrium

Equilibrium

Real Output

t Real Output

t

Demanded

Price Level

Supplied

(Billions)

(Index Number) (Billions)

AS

$506 108

$513

508 104 512

510 100 510

Price Level

100

Equilibrium

LO: 7-3

512 96 507

514 92 502

Equilibrium Price Level and

Equilibrium Real GDP

LO: 7-3

AD

510

Real Domestic Output, GDP (Billions of Dollars)

7-13

7-14

Using the AD-AS Model to Explain

Inflation and Recession

• When aggregate supply and aggregate demand

change, inflation and recession can occur in the

short run.

Demand-pull inflation occurs when aggregate

demand increases (AD curve shifts to the right).

• Cost-push inflation occurs when the costs of

production rise (AS curve shifts to the left).

• Recession occurs when aggregate demand falls

(AD curve shifts to the left) and prices are sticky

downwards.

LO: 7-4

7-15

Demand-Pull Inflation

LO: 7-4

Price

Level

P 2

P 1

Increase in Aggregate g Demand

Demand-Pull

Inflation

Q f Q 1

Real Domestic Output, GDP

AS

AD

AD 1

7-16


Cost-Push Inflation

Recession

Decrease in Aggregate g Supply

AS 1

AS

Decrease in Aggregate g Demand

AS

Level

Price

P 2

P 1

Cost-Push

Inflation

b

a

e Level

Price

P 1

b

a

LO: 7-4

Q 1 Q f

Real Domestic Output, GDP

AD

7-17

LO: 7-4

Q 2 Q f

Creates a

Recession

AD 1

AD 2

Real Domestic Output, GDP

7-18

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