Previous model of economy consisted of households, firms,
government and foreign sector.
Prices, wages and interest rates fixed & output determined by
aggregate demand.
Similar to S & D.
AD/AS deals with economy as a whole, NOT individual markets.
AD-AS
General price level ( as
measured by CPI)
Supply and Demand
Price of particular
good/service
Total production of
goods and services
Quantity of a particular
good or service.
Equilibrium
AD
AS curve indicates
price levellevels
(P0) &
ofreal
output
totalproduction/income
expenditure
which will (or
be
Vertical
axis:
general
price
levellevels.
(P). (Y).
Horizontal
axes:
total
production/income
aggregate
(Ysupplied
):
point
demand)
where
at
different
at
AD
various
&
price
AS
intersect.
price
levels.
0
Aggregate demand = C + I + G + X - Z
consumption spending by households (C)
investment spending by firms (I)
government spending (G)
exports (X) minus imports (Z).
2 important questions regarding the aggregate demand curve:
• Why does AD curve slope downwards?
• What determines the position of the AD curve?
3 main reasons for why AD curve slopes downward…
a) The wealth effect
• When prices fall, real value of money increases
• Real value assets increases
• Real wealth of households increases.
• Encourages households to spend more → consumption spending (C) and thus AD
increase.
b) The interest rate effect
• Price level falls →
• less money demanded →
• decline in interest rates →
• increased investment spending (I) →
• Increased quantity of goods and services demanded → aggregate spending
increase.
c) The international trade effect
• Fall in price level →
• decline in interest rates →
• increased outflow of capital in pursuit of higher interest rates →
• greater demand for foreign currency (lower demand for the rand) →
• depreciation of R →
• weaker rand boosts exports (X) slows imports (Z) →
• increase in demand for domestic goods and services demanded →
• increase in AD.
13244
All non-price determinants of C, I, G, X and Z affect the position of the
AD
Changes will result in a shift of the curve.
• Quantity supplied LR independent of the price level → LRAS vertical.
• Total production in LR depends on quantity & quality (productivity) of
FOP.
• LR output AKA potential, full-employment output or natural rate of
output.
• Changes in availability and productivity FOP will shift LRAS curve.