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CHAPTER 32

Aggregate Demand and Aggregate Supply

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Chapter Contents
Aggregate Demand
Changes in Aggregate Demand
Aggregate Supply
Changes in Aggregate Supply
Equilibrium in the AD-AS Model
Changes in Equilibrium

32-2

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Aggregate Demand
Real GDP desired at each price level
Inverse relationship:
• Real balances effect
• Interest rate effect
• Foreign purchases effect

32-3
LO32.1
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The Aggregate Demand Curve

Price level Aggregate


demand

AD

0
Real domestic output, GDP
32-4
LO32.1
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Changes in Aggregate Demand
Determinants of aggregate demand: Shift factors
affecting C, I, G, Xn.
Two components involved:
1. Change in one of the determinants
2. Multiplier effect.

32-5
LO32.2
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Changes in Aggregate Demand Graphed
Increase in
aggregate
demand

Price level

AD2
Decrease in
aggregate AD1
demand AD3

0
Real domestic output, GDP
32-6
LO32.2
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Consumer Spending
Consumer wealth
Household borrowing
Consumer expectations
Personal taxes

32-7
LO32.2
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Investment Spending
Real interest rates
Expected returns:
• Expectations about future business conditions
• Technology
• Changes in excess capacity
• Business taxes
32-8
LO32.2
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Government Spending
Government spending increases:
• Aggregate demand increases (as long as interest
rates and tax rates do not change)
• More transportation projects
Government spending decreases:
• Aggregate demand decreases
• Less military spending 32-9
LO32.2
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Net Export Spending
National income abroad
Exchange rates:
• Dollar depreciation
• Dollar appreciation

32-10
LO32.2
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Aggregate Supply
Total real output produced at each price level.
Relationship depends on time horizon:
• Immediate short run
• Short run
• Long run

32-11
LO32.3
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Aggregate Supply in the Immediate Short Run

Immediate-short-run
aggregate supply
Price level

P1 ASISR

0 Qf
Real domestic output, GDP
32-12
LO32.3
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The Aggregate Supply Curve (Short Run)
AS

Aggregate supply
(short run)

Price level

0 Qf
Real domestic output, GDP

32-13
LO32.3
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Aggregate Supply in the Long Run

ASLR

Price level

Long-run
aggregate
supply

0 Qf
Real domestic output, GDP

32-14
LO32.3
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Changes in Aggregate Supply
Determinants of aggregate supply: Shift factors
Collectively position the AS curve
Changes raise or lower per-unit production costs

32-15
LO32.4
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Changes in Aggregate Supply Graphed
AS3
AS1
AS2
Decrease in
aggregate supply

Price level

Increase in
aggregate supply

0
Real domestic output, GDP

32-16
LO32.4
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Input Prices
Domestic resource prices:
• Labor
• Capital
• Land
Prices of imported resources:
• Imported oil
• Exchange rates 32-17
LO32.4
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Productivity
Real output per unit of input
• Increases in productivity reduce costs
• Decreases in productivity increase costs
total output
Productivity = total inputs

total input cost


Per-unit production cost = total output
32-18
LO32.4
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Legal-Institutional Environment
Legal changes alter per-unit costs of output:
• Business taxes and subsidies
• Government regulation

32-19
LO32.4
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The Equilibrium Price Level and Equilibrium Real GDP

AS
Real Output Real Output
Price level (index numbers)

Demanded Price Level Supplied


(Billions) (Index Number) (Billions)
$506 108 $513
508 104 512
100 510 100 510
a b 512 96 507
92
514 92 502
AD

0 502 510 514


Real domestic output, GDP
(billions of dollars)

32-20
LO32.5
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An Increase in Aggregate Demand That Causes Demand-
Pull Inflation
AS

P2
Price level

P1

AD2
AD1

0 Qf Q 1 Q 2
Real domestic output, GDP
32-21
LO32.6
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A Recession Resulting from a Leftward Shift of Aggregate
Demand When the Price Level Is Downwardly Inflexible
AS

Price level

b
P1 a
P2 c

AD2 AD1

0 Q 1 Q2 Qf
Real domestic output, GDP

32-22
LO32.6
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Decreases in AD: Recession and Cyclical
Unemployment
Prices are downwardly inflexible:
• Fear of price wars
• Menu costs
• Wage contracts
• Efficiency wages
• Minimum wage law 32-23
LO32.6
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Global Perspective 32.1

32-24
LO32.6
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Source: Organisation for Economic Co-operation and Development (OECD).
A Decrease in Aggregate Supply That Causes Cost-
Push Inflation
AS2
AS1

Price level
P2 b

P1 a

AD

0 Q 1 Qf
Real domestic output, GDP
32-25
LO32.6
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Growth, Full-Employment, and Relative Price Stability

AS1
AS2

Price level P3 b
P2 c
P1 a

AD2
AD1

0 Q1 Q2 Q3
Real domestic output, GDP

32-26
LO32.6
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Last Word: Stimulus and the Great Recession (1 of 2)
Housing collapse triggers bank failures which leads to
recession.
Federal Reserve intervenes: Lowers short-term
interest rates.
Federal government begins largest peacetime
program of spending.

32-27

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Last Word: Stimulus and the Great Recession (2 of 2)

GDP growth has been disappointing.


High debt load due to low interest rates.
High rate of savings.
Unequal impact.
Price increases rather than output gains.
32-28

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