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Aggregate Demand and Aggregate Supply

Aggregate Demand and Aggregate Supply. Aggregate Demand. Not the same as “Demand” that you learned about in Chapter 3!

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Aggregate Demand and Aggregate Supply

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  1. Aggregate Demand and Aggregate Supply

  2. Aggregate Demand • Not the same as “Demand” that you learned about in Chapter 3! • Aggregate Demand is the curve/schedule that shows the amount of Total goods/services desired (demanded) at various price levels by consumers, businesses, government, and foreign buyers • More of a generalization that “demand” as we learned it in chapter 3….

  3. Other difference between Demand and Aggregate Demand • The Graph….

  4. Why is there an inverse relationship between price level and GDP? • Wealth Effect - Higher prices = lower purchasing power, vice versa • Interest-Rate Effect - Higher prices = higher interest rates = less investment = less production (GDP) • Foreign Purchases Effect - Higher prices in U.S = decreased demand for domestic goods/services = increased imports, decreased net exports = decrease in GDP

  5. Determinants of Aggregate Demand Things that shift the AD curve: • Change in consumer spending • Consumer wealth • Consumer expectations • Household indebtedness • taxes • Change in Government spending

  6. Change in investment spending • Interest rates • Profit expectations on investment projects • Business taxes • Technology • Degree of excess capacity • Change in net export spending

  7. Aggregate Supply • Not the same as “supply” from Chapter 3! • AS is the curve/schedule showing the real gdp produced at each price level • The graph has three segments that are IMPORTANT to understand!!!! • Graph and Stinger…

  8. AS Curve

  9. Determinants of Aggregate Supply • Change in input prices - land, labor, capital, E.A. 2. Change in productivity = output / input 3. Change in legal-institutional environment • taxes/subsidies • Government regulations

  10. Increase in AD on the AS curve - • Depending on the range of the AS curve you are in, price level/Output will increase • The multiplier applies to this increase, but the multiplier is weakened by Price Level increases • Any increase in AD leads to an increase in Real GDP. However, the larger the increase in PL, the smaller the increase in Real GDP • In the intermediate and Vertical range, an increase in demand constitutes DEMAND-PULL INFLATION!!!

  11. What about when AD decreases? • Rule of thumb—prices and wages are “flexible” upwards but “inflexible” downwards. • This means that price level will gladly raise, but does not want to lower with a reduction in output….this is called the ratchet effect!

  12. Ratchet Effect

  13. So, as a result of the ratchet effect • When AD decreases, PL stays constant but production/output decreases…. • This explains why prices stay stable/high during times of economic recession (like now) • Get it????

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