Chapter 08

Aggregate
Demand and
Aggregate
Supply

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 Chapter Outline
• Aggregate Demand
• Aggregate Supply
• Shifts in Aggregate Demand
and Aggregate Supply
• Causes of Inflation
• Supply-Side Economics
• How the Government Can
Influence (but probably not
control) the Economy
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 Aggregate Demand

• Aggregate Demand: the

amounts of real domestic output
which domestic consumers,
businesses, governments, and
foreign buyers collectively will
desire to purchase at each
possible price level

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 Figure 1 Aggregate Demand
PI

AD

RGDP
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 Why Aggregate Demand is
Downward Sloping
• Real Balances Effect
• Because higher prices reduce real spending
power, prices and output are negatively
related.
• Foreign Purchases Effect
• When domestic prices are high, we will export
less to foreign buyers and we will import more
from foreign producers. Therefore higher
prices leads to less domestic output.
• Interest Rate Effect
• higher prices lead to inflation which leads to
less borrowing and a lowering of RGDP

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 Aggregate Supply

• Aggregate Supply: the level

of real domestic output
available at each possible price
level

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Figure 2 The Aggregate Supply
Curve AS
PI
Classical
Range

Intermediate
Range

Keynesian Range

RGDP
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 The Ranges of AS
• Keynesian Range
• Large amounts of unemployment make it so
that increases in aggregate demand have no
affect on wages or prices.
• Classical Range
• Full employment makes it so that increases in
aggregate demand only increase wages or
prices.
• Intermediate Range
• Some sectors of the economy reach full
employment more quickly than others.

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 Variables that Shift Aggregate
Demand
• Taxes
• Interest Rates
• Confidence
• Strength of the Dollar
• Government Spending

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 Determinants of AD
Variable GDP Effect of an Effect of a
Compone increase on decrease on
nt C,I,G,X AD AD
Taxes C,I Decrease Increase so
so AD =>
AD <=
Interest C,I Decrease Increase so
Rates so AD =>
AD <=
Confidence C,I Increase so Decrease
AD => so
AD <=
Strength of X Decrease Increase so
the Dollar (exports- so AD =>
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 Figure 3 AD Increases

PI AS

PI’

PI*

AD’

AD

RGDP* RGDP’ RGDP

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 Figure 4 AD Decreases

PI AS

PI*

PI’

AD

AD’

RGDP’ RGDP*
RGDP
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 Variables that Shift AS

• Input Prices
• Productivity
• Government Regulation

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 Determinants of AS
Variable Effect of an Effect of an
Increase on Decrease on
AS AS
Input Prices Decrease Increase so
so AS
AS
Productivit Increase so Decrease
y AS so
AS
Governmen Decrease Increase so
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 Figure 5 Increase in AS
PI
AS

AS’

PI*

PI’
AD

RGDP* RGDP’ RGDP

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 Figure 6 Decrease in AS
PI AS’

AS

PI’

PI*

AD

RGDP’ RGDP*
RGDP
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 Causes of Inflation

• Demand Pull Inflation:

inflation caused by an increase
in aggregate demand
• Cost Push Inflation: inflation
caused by a decrease in
aggregate supply

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 Government Influence:
Aggregate Demand
• Government can influence
economic activity with
aggregate demand side policies
affecting:
• Taxes
• Government Spending
• Interest Rates

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 Government Influence:
Aggregate Supply
• Government can influence economic
activity with aggregate supply side policies
affecting
• input costs (labor and wage)
• reducing regulation
• Increase incentives to
• Work
• Take Risks
• The actions are call Supply Side
Economics

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