Summary AD o Definition: Quantity of real GDP demanded Total amount of final goods and services produced in the economy that people (consumers), businesses, governments, and foreigners plan to buy for, given the price level. Total demand for final goods and services in an economy Aggregate = total and demand = expenditure / spending. Hence AD = Total expenditure or Aggregate expenditure (AE) Since AE = C + I + G + (X – M), then AD = C + I + G + (X – M)
o Factors that can influence AD
Price level Affects change in quantity of real GDP demanded Will NOT cause a shift in AD curve, will only cause a movement along the AD curve Govt policies Affects change in AD Will cause a shift in the AD curve to the left or right Expectations on the economy in the future Affects change in AD Will cause a shift in the AD curve to the left or right Change in variables from foreign countries (eg. Change in foreign countries’ GDP, change in foreign countries’ price level etc) Affects change in AD Will cause a shift in the AD curve to the left or right o AD Curve A curve showing the inverse / negative relationship between price and quantity of real GDP demanded When price level increases → quantity of real GDP demanded reduces (upward movement along the AD curve) AD curve = downward sloping. o Why? 1. Wealth effect When price level increases while other things remain the same, ceteris paribus → real wealth ↓ → the economy demand less goods and services → quantity of real GDP ↓ 2. Substitution effect price level increases while other things remain the same → interest rate ↑ → saving ↑ → quantity of real GDP ↓ price level increases while other things remain the same → domestic goods = relatively more expensive than foreign goods → imports ↑ → quantity of real GDP ↓ o Shift in AD curve Caused by factors other than change in price level If AD increases → AD curve shifts to right If AD decreases → AD curve shifts to left Factors that can shift AD: Govt policies o Fiscal Policy (The only govt policy to influence the economy using tax (T) and government spending (G)) 1. Tax (T) T ↓ → disposable income ↑ → C and I ↑ → AD ↑ → AD curve shifts to right T ↑ → disposable income ↓ → C and I ↓ → AD ↓ → AD curve shifts to left 2. Government spending (G) G ↑ → AD ↑ → AD curve shifts to right G ↓ → AD ↓ → AD curve shifts to left o Monetary policy (central bank’s policy to influence the economy using money supply (Ms) and interest rate (r)) 1. Ms ↑ → r ↓ → C and I ↑ → AD ↑ → AD curve shifts to right 2. Ms ↓ → r ↑ → C and I ↓ → AD ↓ → AD curve shifts to left Expectations o If consumers and firms expect the economy to be better in the future → C and I ↑ → AD ↑ → AD curve shifts to right o If consumers and firms expect the inflation rate will be higher in the future → current C and I ↑ → AD ↑ → AD curve shifts to right Change in variables from foreign countries o If domestic currency depreciates / decrease in value in exchange rate → domestic goods = cheaper in foreign markets while foreign goods = more expensive in domestic market → X ↑ and M ↓ → AD ↑ → AD curve shifts to right o If foreign countries’ GDP ↑ → Foreign countries buy more domestic goods → X ↑ → AD ↑ → AD curve shifts to right AS o Definition The quantity of real GDP supplied The total quantity (output) that firms plan to produce during a given period, given the price level. o Can be separated into: Short run AS (SAS) In the SR, some resources will not be utilized (inefficiency). Hence current real GDP ≠ potential real GDP Wage rate and prices of resources = remain constant SRAS curve = upward sloping Price ↑ → firms ↑ productions → quantity of real GDP supplied ↑ → upward movement along the SRAS curve Long run AS (LAS) In the LR, all resources will be fully utilized. Hence real GDP = potential GDP LRAS curve = vertical Potential GDP will not be influenced by price level o Factors that can influence AS Price level Price ↑ → firms ↑ productions → quantity of real GDP supplied ↑ → upward movement along the SRAS curve Change in the prices of factors Only cause a change in SRAS (only SRAS curve shifts) Prices of factors ↑ → cost of production ↑ → firms reduce productions → SRAS ↓ → SRAS curve shifts to left Actual GDP Δ but no change in potential GDP
Change in the quantity and quality of factors
Cause a change in both SRAS and LRAS When quantity or quality of factors ↑ → firms can produce more outputs → SRAS and LRAS ↑ → Both SRAS and LRAS curves shift to right Both actual GDP and potential GDP Δ Long Run equilibrium o Occurs when AD = SRAS = LRAS o Actual GDP = potential GDP = full employment GDP
o o If Actual GDP > potential GDP = Inflationary gap o If Actual GDP < potential GDP = deflationary gap