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Outline of Presentation
1. Aggregate Demand and Aggregate Demand Curve
2. Why AD Curve slopes downward
3. Shifters/Factors Affecting Aggregate Demand
4. Aggregate Supply and Aggregate Supply Curve
Short-run aggregate supply
Long-run aggregate supply
ADRIANE JOHN P. LUNCIDO
Professor-in-Charge 5. Shifters/Factors Affecting Aggregate Supply

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Aggregate Demand for

Goods and Services
- is the sum of the quantities of goods
and services demanded by households,
firms, government and of the net
exports demanded by foreigners
- Aggregate demand for goods and
services depend on decisions made by
households, firms, government and
foreigners

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Why does AD curve slope

Aggregated Demand Curve downward?
- ADC plots the quantity of real GDP demanded against the price level. If the price of all goods increases and people demand a
- Aggregate demand refers to the relationship smaller quantity of all goods, what do they demand a larger
quantity of? What do they substitute for goods and services?
between the quantity of real GDP demanded and the price level. There are three types of substitutes for the goods and
Point Price Level Real GDP (in services that make up real GDP. They are:
(GDP Deflator) $Billion of 1985 A) Money and financial assets
A 110 260
B) Goods and services in the future
B 120 250
C) Goods and services produced in the other countries
C 130 240
D 140 230
E 150 220

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Why does AD curve slope
downward?
▪ People may plan to buy a smaller quantity of the
goods and services that make up real GDP and hold
a larger quantity of money or other financial assets.
▪ They may plan to buy a smaller quantity of goods
and services today but larger quantity of money at
some future
▪ People may decide to buy smaller quantity of the
goods and services made in the Philippines and buy
a larger quantity of goods and services made in
other countries.
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Real money balances effect
▪ Is the effect of a change in the quantity of real GDP demanded. The
quantity of money is the quantity of currency, bank deposits and
deposits at other types of financial institutions held by households
and firm.
▪ Real money is a measured of money based on the quantity of goods
that it will buy.
▪ Real money is measured as the amount of money in pesos divided by
the price level
▪ The real money balances effects is the influence of the quantity of
real money on the quantity of goods and services
▪ Other things being equal, the larger the quantity of real money that
the households and firms are holding, the larger is the quantity of
goods and services bought
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Two influences on Intertemporal
Substitution:
1) Current Prices
2) Interest Rates
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Why does AD curve slope
downward?
▪ Decisions are influenced by the price level and
those influences result in aggregate demand
curve sloping downward. Corresponding to these
decision, we can identify three separate effects of
the price level on the quantity of real GDP
demanded. They are:
a) Real money balances effect
b) Intertemporal substitution effect
c) International substitution effect
Intertemporal Substitution
Effect
The substitution of goods later or of services
later for goods now is called INTERTEMPORAL
SUBSTITUTION EFFECT.
Example of Intertemporal Substitution:
◦ Your decision to buy a new iPhone 6 today instead
of waiting until the end of the month
◦ Your decision to speed up the installation of new
computer production plant.
A lower price level:
A. Lowers current prices relative to expected
future prices
B. Increase the quantity of real money
C. Increases the supply of loans
D. Decreases the demand for loans
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International Substitution Summary

The quantity of real GDP demanded
The substitution of domestic goods and services for Decreases if the price level increases Increases if the price level decreases
foreign goods and services, or of foreign goods and Because of:
services for domestic goods and services is Real money balances effect
international substitution. An increase in the price level, decreases the real A decrease in the price level, increases the real
money supply money supply
Intertemporal substitution effect
Example: Your decision to take a holiday in
Singapore instead of Malita An increase in the price level increases prices today A decrease in the price level decreases prices today
relative to the future and increases interest rates relative to the future and decreases interest rates
International substitution effect
Therefore: A lower Philippine price level, people and An increase in the price level increases the cost of A decrease in the price level decreases the cost of
firms will demand a larger quantity of Philippine domestic goods and services relative to those from domestic goods and services relative to those from
produced goods and services the rest of the world. the rest of the world

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SHIFTERS OF AGGREGATE
DEMAND Illustrative Example
The main influences on aggregate demand Overall Price
Increase in AD
that shift the aggregate demand curve are:
1. Government policy
2. Interest rate
3. Money and wealth
Decrease in AD
4. International factors (foreign exchange
rates, foreign prices, foreign income) ◦

5. Expectations
Quantity
6. Time lags

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Summary
AGGREGATE DEMAND
Decreases if
Government decreases spending or increases
taxes
Increases if
Government increases spending or decreases
taxes
AGGREGATE SUPPLY
Interest rates rise Interest rates fall
Money supply or wealth decreases Money supply or wealth increases
Exchange rate increases or foreign prices Exchange rate decreases or foreign prices
decreases or foreign income decreases increase or foreign income increases
Expected inflation or expected profits Expected inflation or expected profits increase
decrease

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Aggregate Supply MACROECONOMIC SHORT-RUN

❖ Is the sum of the quantities of all final
goods and services produce by all firms
in the economy.
❖ It is measured as real gross domestic products
(GDP)
❖ In studying two macroeconomic time frames:
the SHORT RUN and the LONG RUN.
▪ Is a period over which the prices of goods and
services change in response to changes in
demand and supply but wages and possibly
other input prices, DO NOT CHANGE.
▪ The short run is identified as an important time
frame because of the common observation that
the prices of the goods and services we buy
change frequently while wages change at less
frequent intervals, often only once a year when
new contracts are negotiated.

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MACROECONOMIC LONG-RUN
❖ is a period sufficiently long for all prices and
wage rates to have adjusted to any disturbance
so that the quantities demanded and supplied
SHORT-RUN AGGREGATE SUPPLY
are equal in all markets (goods and services,
labor markets). (SAS)
❖ Thus, in the macroeconomic long run, with wage
rates having adjusted to bring equality between
the quantities of labor demanded and supplied,
there is full employment. In other words,
unemployment is at its NATURAL RATE.

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Short-run Aggregate Supply

- Short-run aggregate supply is the relationship between the
aggregate quantity of final goods and services (real GDP)
supplied and the price level (the GDP deflator), holding
everything else constant
- The short-run aggregate supply lists quantities of real GDP
supplied at each price level, holding everything else constant.
- The entire short-run aggregate supply curve has three
ranges, namely:
a) Depression range
b) Intermediate range
c) Physical limit range

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Depression Range Intermediate Range

▪ Normally, the economy operates in the upward sloping intermediate range of its
▪ When the economy is severely depressed, Short-Run Aggregate Supply (SAS). This is the part of the SAS curve that is usually
firms have lots of excess capacity and are used for SAS.
anxious to sell whatever they can at the ▪ Over this upward sloping portion of SAS curve, an increase in prices induces firms
going price.. They would be glad to sell to increase output and offer more goods to the market for sale. All firms will
more and willing to offer it for sale without respond in the same manner and the total quantity of output supplied will vary
inducement of a higher price. Each firm with the price level.
(during depression period) has a horizontal ▪ Thus, changes in the price level, with wages rate held constant, lead to a change in
supply curve, making the aggregate supply the aggregate quantity of goods and services supplied and to changes in the level
of employment and unemployment.
curve horizontal as well
▪ The higher the price level, the higher is the aggregate quantity of goods and
services supplied, the higher is the level of employment and the lower is the
level of unemployment

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The Physical Limit to Real GDP Factors that affect/change in SAS

▪ At so e level of real GDP, the SAS becomes vertical because there is a physical 1. Wage Rates. A very important influence on SAS is wage rate. Wage rate affect SAS
limit to the output the economy can produce. through their influence on firms’ costs. The higher the level of wage rates, the higher are
firms’ costs and lower the quantity of output firms want to supply at each price level.
▪ If prices increase while wages remain constant, each firm increases its output. Thus, an increase in wage rates decrease SAS.
It does so by working its labor overtime, hiring more labor and working its plant
and equipment for longer hours 2. Interest Rates. Interest rates, like wage rates, have an effect on the short-run costs of
firms, therefore on SAS
▪ However, there is a limit to the extent to which workers will accept overtime and
there is a lower limit beyond which the employment rate cannot be pushed.
▪ There is also a limit beyond which firms will not want to operate their plant and
equipment because of costly wear and tear (depreciation) and breakdowns.
▪ Once these limits have been reached, no more output can be produced no
matter how high prices become, relative to wages. At that point, SAS becomes
VERTICAL

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LONG-RUN AGGREGATE SUPPLY

(LAS)

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Long-Run Aggregate Supply Curve Long-Run Aggregate Supply Curve

▪ Long run aggregate supply curve is
represented by the long run aggregate
supply curve, which plots the relationship
between the quantity of real GDP
supplied and the price level when wage
rates change along with the price level to
achieve full employment.

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Long-Run Aggregate Supply Curve Changes in both LAS and SAS

▪ The long-run aggregate supply (LAS) curve shows the relationship between full
employment, real GDP and the price level. 1. The labor force
▪ GDP is independent of the price level so the LAS curve is vertical. At levels of 2. The capital stock
real GDP below the long-run level, unemployment is above the natural rate
and levels of real GDP above the long-run level, unemployment is below the 3. The availability of raw materials
natural rate, that is, above full employment.
▪ Fully-employment can occur at any price level. The key thing to remember 4. Technology
about the long-run aggregate supply curve is that two things vary as we move
along it: the price level and wage rate. But the real wage rate – the wage rate 5. Incentives
relative to the price level – does not vary. With a given real wage rate, there is
a unique level of employment and a unique level of real GDP.

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The labor force

▪ the larger the labor force, the
larger is the quantity of the
goods and services produced

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Capital Stock The availability or raw materials

▪ The larger the stock of plant and ▪ The availability of raw materials has
equipment, the more productive is the
labor force and the greater is the labor an important effect on output. The
force and the greater is the output that discovery of new and easily accessed
it can produce. Also, the larger the stock raw materials lower their real cost
of human capital – the skills that people
have acquired through education and and increases output. The depletion
on-the-job training – the greater is the of materials has the reverse effect,
level of output lowering output.

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Technology Incentives
▪ Technology influences aggregate supply in two ▪ Aggregate supply is influenced by the
distinct ways: one positive and permanent, the incentives that people are offered.
other negative but temporary. Inventing new Investment tax credits that cut business
and better ways of doing things enables firms to taxes in proportion to the scale of a firm’s
produce more from any given amount of inputs.
So, even with a constant population and investment in new plant and equipment.
constant capital stock, improvements in Such credits provide an overview provide
technology increase production and increase an incentive to greater capital
aggregate supply. This effect is positive and accumulation and, other things being
permanent. Technological change creates new equal, increase aggregate supply.
jobs and destroy old ones.

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Summary
Aggregate Supply Quotes for the Day!
Decreases and both curves shift to the Increases and both curves shift to the
left if: right if: “There should be no boundary to human endeavor
The labor force decreases The labor force increases just as wide as the universe. Even if life may seem so
The capital stock decreases The capital stock increases bad, there is always something that you can do and
Raw materials become less available or Raw materials become more available succeed at. While there is life, there is HOPE.”
more costly or less costly
Technological change increases the Technological change increases the ~ Stephen Hawkings
rate of job creation and destruction productivity of labor and capital
Incentives to work and invest in new Incentives to work and invest in new
plant and equipment are not plant and equipment are strengthened
strengthened

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THANK YOU FOR LISTENING

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