Aggregate Demand (AD) and Aggregate Supply (AS)
Aggregate demand
Aggregate demand is the total demand for a country’s output at a given price level.
The curve is downwards sloping because, as the price level drops, the quantity of output
demanded increases.
1. The wealth effect
Rise in price level – reduced goods and services consumers can buy, purchasing
power of savings will fall
2. The international effect
Rise in price level – reduced competitiveness for exports, increased competitiveness
for imports
3. The interest rate effect
Rise in price level – increased demand for money – increased interest rates –
reduction in consumption and investment
AD = C + I + G + (X-M)
Consumer expenditure – household spending on consumer goods and services (consumer
expenditure)
Determinants: disposable income, confidence, rate of interest, wealth, population size,
distribution of income
Investment - spending on capital goods by private sector
Determinants: rise in business confidence, cut in corporation tax, advances of technology
Government spending – government spending on goods and services
Determinants: desire to stimulate economic activity, desire to win political support
Net exports – difference between exported goods and services and value of imports
Determinants: fall in exchange rate, rise in quality of domestically produced products,
increase in incomes abroad
Aggregate supply
Aggregate supply is the total supply that domestic producers are willing and able to sell at a
given price level.
The curve slopes up from left to right. As price level increases, producers are willing and
able to supply higher quantities.
1. The profit effect
Price level increase – production costs stay the same – profit increases, incentive to
produce
2. The cost effect
Average cost may rise as output increases regardless of wages and raw materials
remain at the same price, this is followed by producers asking higher prices
3. The misinterpretation effect
Producers might confuse changes in price level with changes in relative prices (for
their own product) and therefore may produce more
Shifts and movements along SRAS
Factors causing shifts
 Wages
 Raw material/ commodity
prices
 Business taxes
 Import prices (firms relying on
imports)
Movements along the aggregate supply curve are caused by changes in the price level.
Long run aggregate supply
Factors causing shifts:
 Increased technology and investment
 Improved productivity
 Improved infrastructure
 Enterprise/ stimulation of invention and innovation
 Expanding the labour supply (migrants)
 Finding new resources
Macroeconomic equilibrium is achieved when AD=AS.