Aggregate Demand and Aggregate Supply (Chapter 20

of Mankiw)

N. Gregory Mankiw, “Principles of Macroeconomics,” 8th Edition, Cengage Learning.

IBE201 Principles of Macroeconomics, Sophia University FLA

1 / 24
Introduction: Economic Fluctuations

Economic activity (such as production, consumption,

and investment)
Fluctuates from year to year
Recession:
Economic contraction
Period of declining real incomes and rising
unemployment
Depression: severe recession

2 / 24
 Figure 1A Look at Short-Run Economic Fluctuations

This figure shows real GDP in panel (a), investment spending in panel (b), and unemployment
in panel (c) for the U.S. economy. Recessions are shown as the shaded areas. Notice that real
GDP and investment spending decline during recessions, while unemployment rises.
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 4
management system for classroom use.

3 / 24
 Figure 1A Look at Short-Run Economic Fluctuations

This figure shows real GDP in panel (a), investment spending in panel (b), and unemployment
in panel (c) for the U.S. economy. Recessions are shown as the shaded areas. Notice that real
GDP and investment spending decline during recessions, while unemployment rises.
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 5
management system for classroom use.

4 / 24
 Figure 1A Look at Short-Run Economic Fluctuations

This figure shows real GDP in panel (a), investment spending in panel (b), and unemployment
in panel (c) for the U.S. economy. Recessions are shown as the shaded areas. Notice that real
GDP and investment spending decline during recessions, while unemployment rises.
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use
as permitted in a license distributed with a certain product or service or otherwise on a password-protected website or school-approved learning 6
management system for classroom use.

5 / 24
Classical Economics: A Recap

The previous chapters are based on the ideas of

classical economics:
The Classical Dichotomy: the separation of
variables into two groups:
Real variables
Nominal variables
The neutrality of money: Changes in the money
supply affect nominal but not real variables.

6 / 24
Classical Economics: A Recap

Most economists believe classical theory describes the

world in the long run, but not the short run.
In the short run, changes in nominal variables (like the
money supply or P) can affect real variables (like Y or
the unemployment rate).
To study the short run, we use a new model
(AD-AS model).

7 / 24
The Aggregate-Demand (AD) Curve
(Draw a diagram with AD curve)

8 / 24
Why the AD Curve Slopes Downward (1)
The wealth effect (P & C)

9 / 24
Why the AD Curve Slopes Downward (2)
The Interest-Rate Effect (P & I)

10 / 24
Why the AD Curve Might Shift
(Example)

11 / 24
Why the AD Curve Might Shift
Changes in C

Changes in I

12 / 24
Why the AD Curve Might Shift (continued)

Changes in G

13 / 24
The Long-Run Aggregate-Supply Curve (LRAS)

14 / 24
Why the LRAS Curve Might Shift
Changes in L or natural rate of unemployment

Changes in K or H

15 / 24
Why the LRAS Curve Might Shift (continued)
Changes in natural resources

Changes in technology

16 / 24
The Short Run Aggregate Supply Curve (SRAS)

17 / 24
Why the SRAS Curve Slopes Upward (1)
Sticky wage theory

18 / 24
Why the SRAS Curve Slopes Upward (2)
Sticky price theory

19 / 24
What 2 Theories Have in Common
(Draw a diagram with SRAS Curve here)

20 / 24
SRAS and LRAS

The imperfections in these theories are temporary.

Over time, sticky wages and prices become flexible
In the long run,

PE = P

and AS curve becomes vertical.

21 / 24
Why the SRAS Curve Might Shift

Everything that shifts LRAS shifts SRAS, too.

22 / 24
The Long-Run Equilibrium
(Draw a diagram with the SRAS, LRAS, and AD Curves)

23 / 24
The Effects of a Shift in AD: Stock Market Crush
(Draw a diagram here)

24 / 24