 AD curve is downward sloping because of the reverse relationship between price and spending (AD). Why AD curve slopes downward ? or Why aggregate demand for output falls at higher aggregate price? PRICE LEVEL P1 P2 AD    Y1 Y2 Aggregate Output .

. Real Balance Effect: With rise in general price level.   Resultantly. they will consume less therefore demand will go down as well AD slopes downward. the real value of monetary asset will fall making people feel poorer than before.

demand for investment in new capital goods (machinery. plant . Hence slope of AD is downward . Resultantly AD will go down .      . At given the money supply. At higher rate of interest. people will require more money for purchasing and transaction purpose. increase in demand of money will cause the rate of interest to go up. This will lead to the increase in the demand for money for transaction. equipment) will decline.  Rate of Interest Effect: At a higher price level.

for domestic products. Foreign Trade effect : The rise in general price level will lead to decline in export which reduces income and whereby aggregate demand curve slopes downward. .   Increase in imports because of fall in price of imported products will lead decline in demand .

Short run AS comprising of three stages: AS Vertical range Intermediate Range Price Level Horizontal Range Capacity Output  AS Y Aggregate Output YF . There is direct relationship between price rise and aggregate supply.

in horizontal range of output upto Y.   In depression while product prices and wages are inflexible downward it is real output will fall and AS Will be horizontal. .  Horizontal Range: As per Keynes.1. Since other resources are lying unused resultantly there will not be higher cost per unit or rise in the price level if aggregate output is expanded in the range. the economy can expand its production without facing rise in unit cost of production because at this time economy is in the grip of recession with high unemployment and unutilized machinery.

Because: As national production expands some industries. Due to shortage of engineers for some crucial industries bottleneck in production may arise which will push up the cost in these industires whereby price level upward. whereby AS curve is upward sloping. like electronics and computer hardware may experience shortage of skilled engineers.   . Intermediate Range  In this range (between Y and YF) increase in aggregate output brings about rise in price level.

 In order to overcome shortage of skilled labour less skillful workers may be employed resulting in rise in unit cost of production. Before full employment of resources.   . some industries may experience shortage of raw material due to expansion of production encounters rising unit cost of production. Most important factor cost is the decline in factor of labour as employed in expanding responsible for rising marginal products of more of them are production.

AS is perfectly inelastic or vertical at the full employment level of output (YF)  Vertical shape of AS curve implies that any further rise in the price level will fail to cause any increase in aggregate output because the economy is already using its available resources fully and producing its potential output. .  Vertical Range: As per classical economist In this range.

 P1 C D Aggregate Output (Real GDP) . short-run equilibrium is reached. Short run macroeconomic occurs at the price level at which AD = AS. AD P2 P0 A E B AS At point E where AD intersects AS at P0 price level and real GDP is Y0.