Aggregate Demand and

Aggregate Supply

Dr Pinki Shah
01/13/22 2
 What is Aggregate Demand
Aggregate demand is the relationship between
the quantity of real GDP demanded and the
price level.
• It represents the amount of goods and
services that consumers, businesses,
government and foreign buyers are willing
and able to buy at various price levels
• AD= C+I+G+(X-M)

01/13/22 3
 Aggregate Demand curve

AD curves shows the relationship between the

price level and the level of real expenditure
in the economy.
Or
The aggregate demand curve shows the level of real GDP
purchased in the economy at different price levels
during a period of time.

Price level is the average level of prices in the

economy. A change in the price level is
inflation.
01/13/22 4
 Aggregate Demand Curve

140
e'
130
Price level

d'
120
c'
110
b'
100
e'
90
AD
6.0 6.5 7.0 7.5 8.0
Real GDP (trillions of 1992 dollars)
 What can cause a shift in the
Aggregate Demand Curve?

Consumption, investments,
government spending and
net exports

6
 Consumption and Investment
Consumption -Consumption is the expenditure by
household on final goods and services. There are
number of factors which determine how much a
household consume, the most important
determinant is disposable income.

Investment -Investment is the addition to the

capital stock of the economy

01/13/22 7
 Investment

• Induced Investment
– Investments that are profit or income motivated

• Autonomous investment
– Independent of income & influenced by exogenous
factors

January 13, 2022 8

 Changes in Aggregate Demand

140
Increase in
130 aggregate
Price level

demand
120

110

100
Decrease in AD1
90 aggregate
demand
AD2 AD0
6.0 6.5 7.0 7.5 8.0
Real GDP (trillions of 1992
01/13/22 dollars) 9
 Aggregate Supply Curve?
The curve that shows the level of real GDP
produced at different price levels during a time
period, ceteris paribus

or

• AS is the total output that firms in the

economy are willing and able to supply
at a given price level in a given period of
time
10
 Short run AS curve
Short run AS curve
• Short run aggregate supply is the output, which
will be supplied at different, price levels in a
period of time, when it is assumed that the price
of the factors of production remain unchanged
so as the short run wage rate.
• So the SRAS is very shallow and it slopes from
left to right. This is because firms will face some
increased cost such as overtime payment when
they increase output.

01/13/22 11
 Aggregate Supply
Price Level SRAS
For our analysis, we
will assume the AS
curve looks like this!

Real GDP
 Shift in the short run AS curve

• There are some Factors, which are called

supply side shocks, which cause the SRAS
curve to shift, are, wage rates, raw
material prices and taxation.

01/13/22 13
 Long run AS curve
• Long run AS curve
Long run AS is the output, which firms
would produce after the price level and
factor prices have fully adjusted after
any shift in AD.
• Keynesian often illustrate the LRAS curve as
perfectly elastic at low level of output, then upward
sloping over a range of output, and finally perfectly
inelastic. Their view is that in the long run the
economy can operate at any level of output and not
necessarily at its full capacity.

01/13/22 14
 Long run AS curve
• New classical economist illustrate that
LRAS curve as a vertical line because that
believe that, in long run, the economy will
operate at full capacity.
• But both agree that factors, which will shift the
vertical part of the LRAS curve, are the changes in
the quantity and quality of resources, as these will
affect the productive capacity of the country.
The AS curve shows the level of total output in the
whole economy at any given level of average prices.

01/13/22 15
 Aggregate Supply
Price Level LRAS Classical
economists
assume the long
run aggregate
supply curve
(LRAS) is vertical
(perfectly
inelastic).

Yf Real GDP

01/13/22 16
 Aggregate Supply Fundamentals
• The quantity of real GDP supplied (Y) depends
upon:

• The quantity of labor (N)

• The quantity of capital (K)

• The state of technology (T)

• The aggregate production function describes
how these factors influence the quantity of
GDP supplied.

01/13/22 17
• Aggregate demand and aggregate supply
analysis determines the equilibrium price level
and the equilibrium real GDP by the
intersection of the aggregate demand and the
aggregate supply curves.

01/13/22 18
 Long-Run Equilibrium
• The intersection of the
aggregate demand
curve and the long-run
aggregate supply curve Price
determines the Level Long-run Short-run
economy’s equilibrium aggregate aggregate
supply supply
output and price level.
• At long-run
equilibrium:
– Output is at its Equilibr
A
ium
natural rate. price
– The short-run
aggregate supply
curve also passes Aggregate
through the point of demand
intersection. Natural Quantity of
0
01/13/22 rate Output 19
of output