PowerPoint Presentation by
Mehdi Arzandeh, University of Manitoba
Aggregate Demand
and Aggregate
Supply
12
LEARNING OBJECTIVES
LO12.1
LO12.2
LO12.3
LO12.4
LO12.5
LO12.6
Define aggregate demand (AD) and explain how its downward slope is the result of
the real-balances effect, the interest-rate effect, and the foreign-trade effect.
Explain the factors that cause changes (shifts) in AD.
Define aggregate supply (AS) and explain how it differs in the immediate short run,
the short run, and the long run.
Explain the factors that cause changes (shifts) in AS.
Discuss how AD and AS determine an economy’s equilibrium price level and level of
real GDP.
Describe how the AD–AS model explains periods of demand–pull inflation, cost–
push inflation, and recession.
© 2016 McGraw‐Hill Education Limited
12-2
12.1 Aggregate Demand
• Aggregate demand is a schedule or curve that
shows the amounts of real output (real GDP) that
buyers collectively desire to purchase at each
possible price level
LO1
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The Aggregate Demand Curve
Price level
FIGURE 12-1
AD
0
LO1
Real domestic output, GDP
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12.1 Aggregate Demand
•
Slopes downward because of the following
effects of a change in price level:
1. Real-balances Effect
2. Interest-rate Effect
3. Foreign Trade Effect
LO1
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Changes in Aggregate Demand
Price level
FIGURE 12-2
AD2
AD3
0
LO2
AD1
Real domestic output, GDP
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12.2
Changes in Aggregate
Demand
Determinants of Aggregate Demand
CONSUMER SPENDING
• Consumer wealth
• Household borrowing
• Consumer expectations
• Personal taxes
LO2
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12.2
Changes in Aggregate
Demand
INVESTMENT SPENDING
• Real Interest Rates
• Expected Returns
• Expectations about future business conditions
• Technology
• Degree of excess capacity
• Business taxes
LO2
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12.2
Changes in Aggregate
Demand
GOVERNMENT SPENDING
• Government spending increases, aggregate demand
increases (as long as interest rates and tax rates do not
change)
• e.g. More computers for government agencies
• Government spending decreases, aggregate demand
decreases
• e.g. Less transportation projects
LO2
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12.2
Changes in Aggregate
Demand
NET EXPORT SPENDING
• National income abroad
• Exchange rates
• Dollar depreciation
• Dollar appreciation
LO2
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12.3 Aggregate Supply
• Aggregate supply is a schedule or curve showing
the relationship between the price level of
output and the amount of real domestic output
that firms in the economy produce
LO3
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12.3 Aggregate Supply
• Aggregate supply depends on three time
horizons:
• The immediate short run
• The short run
• The long run
LO3
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12.3 Aggregate Supply
• Aggregate Supply in the Immediate Short Run
• In the immediate short run, both input prices and
output prices are fixed
• In the immediate short run, the aggregate supply curve
is horizontal at an economy’s current price level
• With output prices fixed, firms collectively supply the
level of output that is demanded at those prices
LO3
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FIGURE 12-3
Aggregate Supply in the Immediate Short Run
Price level
Immediate-short-run
aggregate supply
P1
0
ASISR
GDPf
Real domestic output, GDP
LO3
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12.3 Aggregate Supply
• Aggregate Supply in the Short Run
The short run begins after the immediate short
run ends.
The short run is a period of time during which
output prices are flexible but input prices are
either totally fixed or highly inflexible.
LO3
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12.3 Aggregate Supply
The upward-sloping aggregate supply curve AS indicates
a direct (or positive) relationship between the price level
and the amount of real output that firms will offer for sale
The AS curve is relatively flat below the full-employment
output
It is relatively steep beyond the full-employment output
LO3
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FIGURE 12-4
Short-Run Aggregate Supply Curve
AS
Price level
Aggregate supply
(short run)
0
GDPf
Real domestic output, GDP
LO3
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12.3 Aggregate Supply
• Aggregate Supply in the Long Run
• For the economy as a whole, it is the time horizon over
which all output and input prices are fully flexible
• It begins after the short run ends
• Price-level changes do not affect firms’ profits and thus
they create no incentive for firms to alter their output.
LO3
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FIGURE 12-5
Aggregate Supply in the Long Run
Price level
ASLR
Long-run
aggregate
supply
0
GDPf
Real domestic output, GDP
LO3
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12.4
Changes in Aggregate
Supply
• Determinants of Short-Run Aggregate Supply
• Input prices
•
•
Domestic factor prices
Price of imported resources
• Productivity
• Legal-institutional environment
• Business taxes and subsidies
• Government regulation
LO4
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FIGURE 12-6
Changes in Short-Run Aggregate Supply
AS3
AS1
Price level
AS2
0
LO4
Real domestic output, GDP
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12.5
Equilibrium in the AD-AS
Model
• Equilibrium occurs at the price level that equalizes
the amount of real output demanded and supplied.
• At the intersection of AD and AS:
• Equilibrium price level
• Equilibrium real output
LO5
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FIGURE 12-7
KEY GRAPH – The Equilibrium Price Level and
Equilibrium Real GDP
Price level (index numbers)
AS
100
a
92
b
Real Output
Demanded
(Billions)
Price Level
(Index Number)
Real Output
Supplied
(Billions)
$506
108
$513
508
104
512
510
100
510
512
96
507
514
92
502
AD
0
502
510 514
Real domestic output, GDP
(billions of dollars)
LO5
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12.6 Changes in Equilibrium
•Increases in AD: Demand-Pull Inflation
• For any initial increase in aggregate demand, the
resulting increase in real output will be smaller the
greater is the increase in the price level
• Inflationary (positive) GDP gap
• Demand-pull inflation
LO6
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FIGURE 12-8
An Increase in Aggregate Demand that Causes
Demand-Pull Inflation
Price level
AS
P2
P1
AD2
AD1
0
GDPf GDP1GDP2
Real domestic output, GDP
LO6
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12.6 Changes in Equilibrium
• Decreases in AD:
Recession and Cyclical Unemployment
•
Deflation, a decline in the price level, is a rarity in the
Canadian economy
•
Real output takes the full brunt of the decline in AD
because product prices are “sticky” in the short run
•
LO6
Recessionary (negative) GDP gap
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12.6 Changes in Equilibrium
Reasons for downward price stickiness:
•
•
•
•
•
•
•
LO6
fear of price wars
menu costs
wage contracts
morale, effort, & productivity
minimum wage
menu costs
fear of price wars
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FIGURE 12-9
A Decrease in Aggregate Demand that Causes a
Recession
Price level
AS
b
P1
a
c
P2
AD1
AD2
0
GDP1 GDP2GDPf
Real domestic output, GDP
LO6
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12.6 Changes in Equilibrium
•Decreases in AS: Cost-Push Inflation
• Effects of a leftward shift in AS are doubly bad
• output decreases
• price level increases
LO6
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FIGURE 12-10
A Decrease in Aggregate Supply that Causes a
Cost-Push Inflation
Price level
AS2
AS1
b
P2
P1
a
AD
0
GDP1 GDPf
Real domestic output, GDP
LO6
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12.6 Changes in Equilibrium
•Increases in AS:
Full Employment with Price-Level Stability
• Increases in AD should normally lead to inflation
• In the late 1990s, productivity growth has shifted the longrun AS curve to the right
• Economy slowed down in 2001 due to a substantial fall in
investment spending
• During 2002-2006 economy rebounded but followed by the
recession of 2008-2009.
LO6
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FIGURE 12-11
Growth, Full Employment, and Relative Price
Stability
AS1
Price level
P3
AS2
b
P2
P1
c
a
AD2
AD1
0
GDP1 GDP2 GDP3
Real domestic output, GDP
LO6
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The LAST
WORD
Stimulus and the Great Recession in the
American versus the Canadian Economy
• Aggregate demand stimulus helped to prevent the 2008-2009 downturn
from becoming another Great Depression.
• The US economy entered a recession in 2007, following the housing
collapse.
• To stimulate aggregate demand
• The Federal Reserve lowered short-term interest rates
• The federal government used fiscal policy
• In the US, real GDP fell by 4.7% and unemployment rate rose from 4.6%
to 10.1%.
• In Canada, GDP fell by 2.7% and unemployment rate rose from 6.1% to
8.7%.
• After the recession, GDP growth was higher and unemployment rate
was lower for Canada.
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Chapter Summary
LO12.1 Define aggregate demand (AD) and explain how its
downward slope is the result of the real-balances effect, the
interest-rate effect, and the foreign-trade effect.
LO12.2 Explain the factors that cause changes (shifts) in AD.
LO12.3 Define aggregate supply (AS) and explain how it differs in the
immediate short run, the short run, and the long run.
LO12.4 Explain the factors that cause changes (shifts) in AS.
LO12.5 Discuss how AD and AS determine an economy’s equilibrium
price level and level of real GDP.
LO12.6 Describe how the AD–AS model explains periods of demand–
pull inflation, cost–push inflation, and recession.
© 2016 McGraw‐Hill Education Limited
12-34