Aggregate Supply and Aggregate
Demand
Module 3: National Income, Price Determination, and Economic Growth
D. McKee, 01.09.2013
Source: Economics, Krugman and Wells, Worth Publishing, 2006
Key Points
How the aggregate supply curve illustrates the relationship
between the aggregate price level and the quantity of
aggregate output supplied in the economy
Why the aggregate supply curve different in the short run
compared to the long run
How the aggregate demand curve illustrates the
relationship between the aggregate price level and the
quantity of aggregate output demanded in the economy
How the AS–AD model is used to analyze economic
fluctuations
How monetary policy and fiscal policy can stabilize the
economy
The Short-Run Aggregate Supply Curve
Shifts of the Short-Run Aggregate
Supply Curve
Shifts of the Short-Run Aggregate
Supply Curve
•Changes in
 Commodity prices
 Nominal wages
 Productivity
From the Short Run to the Long Run
The Aggregate Demand Curve
Classical Versus Keynesian
Macroeconomics
Fiscal Policy with a Fixed Money
Supply
Rational Expectations, Real Business Cycles, and
New Classical Macroeconomics
•New classical macroeconomics is an approach
to the business cycle that returns to the classical
view that shifts in the aggregate demand curve
affect only the aggregate price level, not
aggregate output.
•Rational expectations is the view that
individuals and firms make decisions optimally,
using all available information.
The Modern Consensus
Why is the aggregate demand curve
downward-sloping?
 Wealth effect of a change in the aggregate price level
 Interest rate effect of a change in aggregate the price level
Shifts of the Aggregate Demand Curve
– Changes in
 Expectations
 Wealth
 Stock of physical capital
Shifts of the Aggregate Demand Curve
The Multiplier
• The size of the multiplier, 1/1 – MPC, depends
on the marginal propensity to consume, MPC:
the larger the MPC, the larger the change in
real GDP for any given autonomous increase
in aggregate spending.
The Multiplier
The AS–AD Model
Shifts of the SRAS Curve
Shifts of Aggregate Demand: ShortRun Effects
Long-Run Macroeconomic Equilibrium
Short-Run Versus Long-Run Effects of a
Positive Demand Shock
Negative Supply Shocks
Macroeconomic Policy
Fiscal policy affects aggregate demand directly
through government purchases and indirectly
through changes in taxes or government
transfers that affect consumer spending.
Monetary policy affects aggregate demand
indirectly through changes in the interest rate
that affect consumer and investment spending.