Unit 3 Macroeconomics
Chapter 28
Aggregate Demand and Aggregate
Supply
I. Aggregate Demand
a) All the goods and services (real GDP) that
buyers are willing and able to purchase at
different price levels.
1. Inverse relationship
2. If the price level:
i. Increases, then real GDP demanded falls
ii. Decreases, then real GDP demanded increases
II. Aggregate Demand Curve
III. Why AD is downward sloping
a) Wealth effect of a change in aggregate price
level.
1. Higher price level reduces purchasing power and
reduces spending
b) Interest rate effect of a change in aggregate
price level
1. Higher price level reduces purchasing power of
money holdings leading to a rise in interest rates
and a fall in spending.
IV. Shifters of Aggregate Demand
IV. Shifters of Aggregate Demand
1. Change in Consumer Spending
– Consumer wealth, Taxes, Expectations
2. Change in Investment Spending
– Interest Rates, Productivity, Taxes, Expectations
3. Change in Government Spending
– War, National Health Care, Infrastructure
4. Change in Net Exports
1. Exchange Rates, National Income abroad
V. Aggregate Supply
a) The amount of goods and services (real GDP)
that firms will produce in an economy at
different price levels.
b) Short-run Aggregate Supply
1. Wages and resource prices will not increase as
price levels increase.
c) Long-run Aggregate Supply
1. Wages and resource prices will increase as price
levels increase.
VI. Short-Run Aggregate Supply
a) Wages and resource prices will NOT increase as price
levels increase.
Example:
1. A firm currently makes 100 units that are sold for $1
each. The only cost is $80 of labor.
2. How much profit? $20
3. What happens in the SHORT-RUN if price level doubles?
4. 100 units sell for $2, how much is profit?
5. $120
6. With higher profits, the firm has the incentive to increase
production.
VII. Long-Run Aggregate Supply
a) Wages and resources prices WILL increase as price
levels increase.
1.
2.
3.
4.
5.
The firm has TR of $100 and uses $80 on labor.
Profit=$20
What happens in the LONG-RUN if price level doubles?
Now TR = $200
Workers now demand higher wages to match prices. So
labor costs double to $160
6. Profit = $40, but REAL profit is unchanged.
7. If REAL profit doesn’t change the firm has no incentive to
increase output.
VIII. Shifters of Aggregate Supply
a) Change in Inflationary Expectations
1. If people expect higher prices…..
b) Change in Resource Prices
1. Supply Shocks
c) Change in Actions of Government (NOT
government spending)
1. Taxes on producer, subsidies, government regs.
d) Change in Productivity
1. Technology (teleportation machine)
IX. Short Run Equilibrium
a) Aggregate quantity supplied is equal to
aggregate quantity demanded.
X. Long-Run Equilibrium
a) Point of short-run equilibrium is on the longrun aggregate supply curve.
FRQ 2006 AP Test
1. Assume the United States economy is currently operating
at an equilibrium below full employment.
a)
Draw a correctly labeled graph of aggregate demand and
aggregate supply, and show each of the following.
i.
ii.
b)
Now assume a significant increase in the world price of oil, a
major production input for the United States. Show on your
graph in part (a) how the increase in the oil price affects each
of the following in the short run.
i.
ii.
c)
Long-run aggregate supply
Current equilibrium
Short-run aggregate supply
Real output and price level
Given your answer in part (b), explain what will happen to
unemployment in the United States in the short run.