The document describes the concepts of aggregate demand and aggregate supply, which are essential for understanding macroeconomic models. It explains how these components interact to determine a country's output and price levels, emphasizing factors that cause shifts in the aggregate demand curve. Additionally, it highlights the effects of price level changes on real income, exports, and interest rates.

1. Aggregate Demand
and
Aggregate Supply

2. • To understand and use a macroeconomic
model, we first need to understand how the
average price of all goods and services
produced in an economy affects the total
quantity of output and the total amount of
spending on goods and services in that
economy.

3. Aggregate Supply
•Aggregate supply is the total quantity of
output firms will produce and sell—in other
words, the real GDP.

4. Aggregate Demand
• Aggregate demand is the amount of total spending
on domestic goods and services in an economy.
• It is the total (final) expenditure of all the units of the
economy, i.e., households, firms, government, and
the rest of the world.

5. •The aggregate supply and demand model
is the basic macroeconomic tool for
studying output fluctuations and the
determination of the price level and the
inflation rate.

6. Aggregate Supply Curve
•Aggregate supply curve describes the
quantity of output firms are willing to
supply for each given price level. The AS
curve is downward-sloping because firms
are willing to supply more output at
highest prices.

7. Aggregate Demand Curve
•The aggregate demand curve shows the
combinations of the price level and level of
output at which the goods and money
markets are simultaneously in equilibrium.

8. Potential GDP
• Potential GDP—the quantity that an economy can
produce by fully employing its existing levels of labor,
physical capital, and technology, in the context of its
existing market and legal institutions.

9. AD and PL
• A fall in the general price level causes an
expansion of AD
• A rise in the general price level causes a
contraction of AD

12. Why does the aggregate demand curve slope
downwards from left to right?
• Real income effect: As the price level falls, the real value of income rises,
and consumers can buy more of what they want or need – this is known as
the real money balance effect
• Balance of trade effect: A fall in the relative price of level of Country X
could make foreign-produced goods and services more expensive, causing
a rise in exports and a fall in imports. Exports are an injection, imports a
withdrawal.
• Interest rate effect: If price inflation is low and this might lead to a
reduction in interest rates if the central bank has a given inflation target.
Lower interest rates means there is less incentive to save and a fall in
interest rates may cause the exchange rate to depreciate and improve
exports.

15. Shifts in the Aggregate Demand curve
• Shifts in the aggregate demand curve are caused by factors
independent of changes in the general price level.
• An outward shift of AD means a higher level of demand at
each price level. One or more of the components of AD
must have changed. AD1 shifts to AD2.
• An inward shift of AD means that total expenditure on
goods and services at each price level has fallen. AD1 shifts
to AD3.