Econ214 macroeconomics Chapter 9

1. Chapter 9
Aggregate
Demand and
Aggregate Supply

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● short run in macroeconomics
The period of time in which
prices do not change or do not
change very much.
9.1 MACROECONOMIC CONSEQUENCES

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The Components of Aggregate Demand
 FIGURE 9.1
Aggregate Demand
The aggregate demand curve
plots the total demand for real
GDP as a function of the price
level.
The aggregate demand curve
slopes downward, indicating that
the quantity of aggregate
demand increases as the price
level in the economy falls.
9.2 UNDERSTANDING AGGREGATE
DEMAND (cont.)

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Why the Aggregate Demand Curve Slopes Downward
As the purchasing power of money changes, the aggregate demand curve is
affected in three different ways:
THE WEALTH EFFECT
● wealth effect
The increase in spending that occurs
because the real value of money
increases when the price level falls.
R E A L - N O M I N A L P R I N C I P L E
What matters to people is the real value of money or income—its purchasing
power—not the face value of money or income.
9.2 UNDERSTANDING AGGREGATE
DEMAND (cont.)

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Why the Aggregate Demand Curve Slopes Downward
THE INTEREST RATE EFFECT
THE INTERNATIONAL TRADE EFFECT
With a given supply of money in the economy, a lower price level will lead to
lower interest rates.
With lower interest rates, both consumers and firms will find it cheaper to
borrow money to make purchases.
As a consequence, the demand for goods in the economy (consumer durables
purchased by households and investment goods purchased by firms) will
increase.
In an open economy, a lower price level will mean that domestic goods (goods
produced in the home country) become cheaper relative to foreign goods, so
the demand for domestic goods will increase.
9.2 UNDERSTANDING AGGREGATE
DEMAND (cont.)

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Shifts in the Aggregate Demand Curve
CHANGES IN TAXES
CHANGES IN GOVERNMENT SPENDING
CHANGES IN THE SUPPLY OF MONEY
An increase in the supply of money in the economy will increase aggregate
demand and shift the aggregate demand curve to the right.
A decrease in taxes will increase aggregate demand and shift the aggregate
demand curve to the right.
At any given price level, an increase in government spending will increase
aggregate demand and shift the aggregate demand curve to the right.
9.2 UNDERSTANDING AGGREGATE
DEMAND (cont.)

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Shifts in the Aggregate Demand Curve
ALL OTHER CHANGES IN DEMAND
 FIGURE 9.2
Shifting Aggregate Demand
Decreases in taxes, increases in
government spending, and an increase in
the supply of money all shift the aggregate
demand curve to the right.
Higher taxes, lower government spending,
and a lower supply of money shift the curve
to the left.
9.2 UNDERSTANDING AGGREGATE
DEMAND (cont.)

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How the Multiplier Makes the Shift Bigger
 FIGURE 9.3
The Multiplier
Initially, an increase in desired
spending will shift the
aggregate demand curve
horizontally to the right from a
to b.
The total shift from a to c will
be larger. The ratio of the total
shift to the initial shift is known
as the multiplier.
9.2 UNDERSTANDING AGGREGATE
DEMAND (cont.)

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How the Multiplier Makes the Shift Bigger
● multiplier
The ratio of the total shift in
aggregate demand to the initial shift
in aggregate demand.
9.2 UNDERSTANDING AGGREGATE
DEMAND (cont.)

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How the Multiplier Makes the Shift Bigger
● autonomous consumption spending
The part of consumption spending that
does not depend on income.
● marginal propensity to consume (MPC)
The fraction of additional income that is spent.
● marginal propensity to save (MPS)
The fraction of additional income that is saved.
9.2 UNDERSTANDING AGGREGATE
DEMAND (cont.)

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How the Multiplier Makes the Shift Bigger
=
−
1
multiplier
(1 MPC)
9.2 UNDERSTANDING AGGREGATE
DEMAND (cont.)

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The Short-Run Aggregate Supply Curve
What factors determine the costs firms must incur to produce output? The key
factors are
• Input prices (wages and materials)
• The state of technology
• Taxes, subsidies, or economic regulations
9.3 UNDERSTANDING AGGREGATE
SUPPLY (cont.)

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Supply Shocks
● supply shocks
External events that shift the aggregate supply curve.
 FIGURE 9.7
Supply Shock
An adverse supply shock, such
as an increase in the price of oil,
will cause the AS curve to shift
upward.
The result will be higher prices
and a lower level of output.
● stagflation
A decrease in real output with increasing prices.
9.3 UNDERSTANDING AGGREGATE
SUPPLY (cont.)

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K E Y T E R M S
aggregate demand curve (AD)
aggregate supply curve (AS)
autonomous consumption spending
consumption function
long-run aggregate supply curve
marginal propensity to consume (MPC)
marginal propensity to save (MPS)
multiplier
short-run aggregate supply curve
short run in macroeconomics
stagflation
supply shocks
wealth effect