ECO 102
Macroeconomics
Chapter 3
Aggregate Demand and Aggregate Supply
Prof. Dr. Magdy El-Shourbagui
Head of the Department of Economics
College of Business & Economics
Misr University for Science & Technology
www.magdyel-shourbagui.com
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Learning Objectives
 Define the following terms: aggregate demand,
aggregate supply, economy’s potential real
GDP, and macroeconomic equilibrium.
 Distinguish between the aggregate demand
curve and the aggregate supply curve.
 Identify and describe the reasons for downward
slope of the aggregate demand curve.
 Identify and describe the factors that shift the
aggregate demand curve.
 Explain and illustrate graphically the
macroeconomic equilibrium in the short run
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The Meaning of Aggregate Demand
Aggregate Demand, AD is the quantity demanded of all final
goods and services (Real GDP) at different price levels. AD can
be calculated by the following equation:
Real GDP = Y = AD = C + I + G + NX
= C + I + G + (X -M)
Where:
C = personal consumption spending,
I = gross private domestic spending,
G = government spending,
NX = net exports of goods and services,
X = exports of goods and services, and
M = imports of goods and services.
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The Aggregate Demand Curve
The Aggregate demand, AD curve is downward-sloping,
specifying a negative relationship between the price level as
independent variable and the quantity of real GDP demanded
as dependent variable.
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Reasons for Downward slope of the Aggregate Demand
Curve
1. The price level and consumption
(The Real wealth effect or the real
money balance effect),
2. The price level and investment (The
interest rate effect), and
3. The price level and net exports (The
international trade effect).
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1. The price level and consumption (The Real wealth
effect or the real money balance effect),
Real Wealth is the value of money in bank, bonds, stocks, and non-monetary assets people
own measured in terms of what they will buy.
The price
level
consumers feel wealthier
quantity of goods and
services demanded
the real purchasing
power
of
money
balances (currency and
bank deposits) and the
real, monetary wealth
real wealth.
encourages them to spend more
quantity
demanded
of
Real
GDP
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2.
The Price Level and Investment (The Interest
Rate Effect)
the purchasing
power of
money
the domestic
saving
the banks will
provide more loans
supply of credit
money
needed to
buy fixed
bundle of
goods and
services
the interest
rate
spending on investment
goods by households and
businesses
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3. The Price Level and Net Exports (The International
Trade Effect)
the domestic goods will be
cheaper relative to
foreign goods
Exports (X) and
Imports (M)
Net Exports (NX)
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A Change in the Quantity Demanded of the Real GDP: A
Movement along the Aggregate Demand Curve
A change in the quantity demanded of real GDP caused by a change in the price level. It
is shown by a movement along the aggregate demand curve
P
Y
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A Change in Aggregate Demand: Shifts in the
Aggregate Demand Curve
A Change in aggregate demand is the change in the
quantity demanded of real GDP as the change in the
following
factors:
Consumption,
investment,
government spending, and net exports. These factors
will affect the quantity demanded of real GDP at any
given price level.
The aggregate demand curve shifts, when one of
the factors above changes.
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An Increase in Aggregate Demand
An increase in aggregate demand is represented by an outward shift of
the entire aggregate demand curve. If aggregate demand increases,
greater quantities of real GDP are demanded at each possible price level
for the year.
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A Decrease in Aggregate Demand
A decrease in aggregate demand is represented by an inward shift of the
entire aggregate demand curve. When aggregate demand decreases, a
less quantity of real GDP is demanded at each possible price level for the
year.
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Factors that shift the Aggregate Demand Curve
The aggregate demand curve will shift as a result of changes in the following:
1.
2.
3.
4.
Consumption Spending (C);
Investment Spending (I);
Government Spending (G); and
Net Exports (NX).
The AD curve shifts to the right side when aggregate demand increases. However,
the AD curve shifts to the left side when aggregate demand decreases.
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Factors that shift the Aggregate Demand Curve
1. Consumption Spending (C)
The following factors can cause consumption spending to change:
a) Consumer Wealth;
b) Personal Income Taxes; and
c) Expectations about Future Income, and Inflation.
a) Consumer Wealth
Consumer Wealth
Consumption
Spending
(C)
consumers feel wealthier
aggregate
demand
demand for goods
and services
by consumers
rightward shift of the
aggregate demand
curve
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Factors that shift the Aggregate Demand Curve
b) Personal Income Taxes
personal income tax
Consumption
Spending
(C)
disposable income of households
aggregate
demand
rightward shift of the
aggregate demand
curve
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Factors that shift the Aggregate Demand Curve
c) Expectations about Future Income, and Inflation
expected future income
Consumption
Spending
(C)
A increase in expected inflation
Consumption
Spending
(C)
the amount of consumption
goods that people plan to
buy today
aggregate
demand
rightward shift of the
aggregate demand
curve
buying goods and services
cheaper today
aggregate
demand
rightward shift of the
aggregate demand
curve
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Factors that shift the Aggregate Demand Curve
2. Investment Spending (I)
The following factors can cause investment spending to change:
a) Interest Rates;
b) Corporate Profits Taxes; and
c) Expectations about Future Sales.
a) Interest Rates
The interest rates
Investment
Spending
(I)
borrowing by investors
aggregate
demand
rightward shift of the
aggregate demand
curve
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Factors that shift the Aggregate Demand Curve
b) Corporate Profits Taxes
Taxes on profits of firms
Investment
Spending
(I)
firms after-tax profits
aggregate
demand
rightward shift of the
aggregate demand
curve
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Factors that shift the Aggregate Demand Curve
c) Expectations about Future Sales
Expected future sales
Investment
Spending
( I ) today
profits expectations
aggregate
demand
rightward shift of the
aggregate demand
curve
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Factors that shift the Aggregate Demand Curve
3. Government Spending (G)
An increase in government purchases of goods and
services increases aggregate demand. This shifts the
aggregate demand curve to the right
4. Net Exports (NX)
The following factors can cause net exports to change:
a) Foreign Real Income; and
b) Foreign Exchange Rate.
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Factors that shift the Aggregate Demand Curve
a) Foreign Real Income
Foreign real income
(Real GDP of foreign countries)
aggregate
demand
The exports
of the home country
rightward shift of the
aggregate demand
curve
AD = C + I + G + X - M
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Factors that shift the Aggregate Demand Curve
b) Foreign Exchange Rate
Foreign exchange rate
(price of foreign currency )
Exports and
aggregate
demand
Imports
The prices of domestic
goods and services
relative to foreign goods
and services
Net exports
rightward shift of the
aggregate demand
curve
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The Meaning of Aggregate Supply
Aggregate supply, AS is the quantity supplied of all final goods
and services (Real GDP) at different price levels. ). This is
represented by the aggregate production function:
Y = f (N, K, L, T)
Where:
Y = The aggregate supply (Real GDP);
f = depends on;
N = Labor;
K = Capital;
L = Land;
T = The State of Technology.
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The short-Run Aggregate Supply Curve
The Short-Run Aggregate Supply, SRAS curve is upward-sloping,
specifying a positive relationship between the price level as
independent variable and the quantity supplied of real GDP as
dependent variable.
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3.2.2.2 The Long-Run Aggregate Supply
Curve Page 75
till
Figure 3.11: A Change in Aggregate Supply
in the Short-Run: Shifts of the Short-Run
Aggregate Supply Curve page 81
and
3.3.2 Long-Run Macroeconomic
Equilibrium page 82
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1 Short-Run macroeconomic Equilibrium
When the quantity demanded of real GDP equals the quantity
supplied of real GDP, the Short-Run macroeconomic equilibrium
occurs
The short-run equilibrium point (n) is the interaction of the AD curve
and SRAS curve. This intersection determines the equilibrium price
level (Pe) and the equilibrium real GDP (Ye).
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