WRITTEN REPORT

AGGREGATE DEMAND
AND AGGREGATE
SUPPLY
A. Three Key facts about short run economic fluctuations
B. How the economy in the short run differ from the economy in the
long run
C. How to use the model of aggregate demand and aggregate supply to
explain economic fluctuations
D. How shifts in either aggregate demand or aggregate supply can
cause booms and recessions

GROUP 4 1-11 BSA

Lumboy
Manalac
Pacia
Ragot
Manalac, Mark H.
1-11 BSA

A. THREE KEY FACTS ABOUT ECONOMIC FLUCTUATIONS

Short-run fluctuations in economic activity occur in all countries and have occurred throughout
history. It is important to know and understand its most important properties.

Fact 1: Economic Fluctuations Are Irregular and Unpredictable

* Fluctuations in the economy are often called the business cycle. As this term suggests,
economic fluctuations correspond to changes in business conditions.
* When real GDP grows rapidly, business is good. During such periods of economic expansion,
most firms find that customers are plentiful and that profits are growing. When real GDP falls
during recessions, businesses have trouble. During such periods of economic contraction, most
firms experience declining sales and dwindling profits.
* Economic fluctuations are impossible to predict accurately.
*The longest period in U.S. history without a recession was the economic expansion from 1991
to 2001.
Fact 2: Most Macroeconomic Quantities Fluctuate Together
* Real GDP is the variable that is most commonly used to monitor short-run changes in the
economy because it is the most comprehensive measure of economic activity.
* Real GDP measures the value of all final goods and services produced within a given period of
time. It also measures the total income (adjusted for inflation) of everyone in the economy.
* Real GDP is the variable that is most commonly used to monitor short-run changes in the
economy
* When real GDP falls in a recession, so do personal income, corporate profits, consumer
spending, investment spending, industrial production, retail sales, home sales, auto sales, and
so on.
* Because recessions are economy-wide phenomena, they show up in many sources of
macroeconomic data.

Fact 3: As Unemployment Rises, Output Falls

* The GDP and unemployment have an inverse relationship.
During the time of economic contraction, unemployment rised.
- For example during Great Recession and Great depression, unemployment were
exceedingly high.
Lumboy, Shanon Gabrielle A.
1-11 BSA

B. HOW THE ECONOMY IN THE SHORT RUN DIFFER FROM THE ECONOMY IN THE LONG RUN

 In terms of Production Decision:

Short run is a concept that states that, within a certain period in the future, at least one
input is fixed while others are variable. Only some factors or variables can be changed because
there is not enough time to change the others.

Example:
 Quantity of labor is variable but the quantity of capital and production processes
are fixed

Long run is defined as the time horizon in which all factors of production and costs are
variable. Unlike the short run, factors or variables can be changed because there is always
enough time to change the others.
Examples:
 Quantity of labor, the quantity of capital, and production processes

 Fixed cost- expenses that are constant whatever the quantity of goods or services
produced.
 Variable cost- A variable cost is a corporate expense that changes in proportion to
production output.
Pacia, Dominique Audrey T.
1-11 BSA
C. HOW TO USE THE MODEL OF AGGREGATE DEMAND AND AGGREGATE SUPPLY TO EXPLAIN
ECONOMIC FLUCTUATIONS

 Aggregate Demand and Supply Model

Two variables are used to develop a model to analyze short run fluctuations:
1) price levels
2) real GDP

 Aggregate Demand Curve

-shows the quantity of goods and services that households, firms, and the government want to
buy at each price level
-four components of GDP (C+I+G+XN)
  Why the Aggregate Demand Curve is downward sloping
1) The Price Level and Consumption: Wealth Effect
- a lower price level increases real wealth, which encourages spending on consumption
2) The Price Level and Investment: Interest Rate Effect
- a lower price level reduces interest rate, which encourages spending on investment
3) The Price Level and Net Exports: Exchange Rate Effect
- a lower price level causes the real exchange rate to depreciate, which encourages
spending on net exports

 Aggregate Supply Curve

-quantity of goods and services that firms choose to produce and sell at each price level
-In the long run, the aggregate supply curve is vertical
-In the short run, the aggregate supply curve is upward sloping
Ragot, Christine Claire
1-11 BSA
D. HOW SHIFTS IN EITHER AGGREGATE DEMAND OR AGGREGATE SUPPLY CAN CAUSE BOOMS
AND RECESSIONS

 Why Might the Aggregate-Demand Curve Shift?

1. Shifts Arising from Consumption.
An event that makes consumers spend more at a given pricelevel ( a tax cut, a stock market
boom) shifts the aggregate-demand curve to the right. an event that makes conumers spend
less at a given prive level ( a tax hike, a stock market decline) shifts the aggregate-demand curve
to the left.
2. Shifts Arising from Investment.
An event that makes firms invest more at a given price level (optimism about the future, a fall
in interest rate due to an increase in the money supply) shifts the aggregate-demand to the
right. An event that makes the firms invest less at a given price level ( pessimism about the
future, a rise in interest rates due to a decrease in the money supply) shifts the aggregate-
demand curve to the left.
3. Shifts Arising from Government Purchases.
An increase in the government purchases of goods and services ( greater spending on
defense or highway construction) shifts the aggregate-demand curve to the right. a decrease in
government purchases of goods and services( a cutback in defense or highway spending) shifts
the aggregate-demand curve to the left.
4. Shifts Arising from Net Exports.
An event that raises spending on net exports at a given price level ( a boom overseas,
speculation that causes an exchange rate depreciation) shifts the aggregate demand to the
right. an event that reduces spending on net exports at a given price level ( a recession
overseas, speculation that causes an exchange rate appreciation) shifts the aggregate demand
curve to the left.

 Why does the Short-Run Aggregate-Supply Curve Slope Upward?

1. The Sticky-Wage Theory
2. The Sticky-Price Theory
3. The Misperception Theory
  Why Might the Short-Run Aggregate-Supply Curve Shift?
1. Shifts Arising from Labor.
An increase in the quantity of labor available (perhaps due to a fall in the natural rate of
unemployment) shifts the aggregate-supply curve to the right. A decrease in the quantity of
labor available (perhaps due to a rise in the natural rate of unemployment) shifts the aggregate-
supply curve to the left.
2. Shifts Arising from Capital.
An increase in physical or human capital shifts the aggregate-supply curve to the right.
3. Shifts Arising from Natural Resources.
An increase in the availability of natural resources shifts the aggregate-supply curve to the
right. A decrease in the availability of natural resources shifts the aggregate-supply curve to the
left.
4. Shifts Arising from Technology.
An advance in technological knowledge shifts the aggregate supply curve to the right. A
decrease in the availability of technology (perhaps due to government regulation) shifts the
aggregate supply curve to the left.
5. Shifts Arising from the Expected Price Level.
A decrease in the expected price level shifts the short run aggregate supply curve to the right.
An increase in the expected price level shifts the short run aggregate supply curve to the left.

 Why the Long-Run Aggregate-Supply Curve MIght Shift?

1. Shifts Arising from Changes in Labor
2. Shifts Arising from Changes in Capital
3. Shifts Arising from Changes in Natural Resources
4. Shifts Arising from Changes in Technological Knowledge