Macroeconomics: Aggregate Demand and Supply

AGGREgate supply and demand
Goods and Money Market Equilibrium: Bringing Everything Together

Review
• The goods market is in equilibrium where Y = AE.
• The money market is in equilibrium at that interest rate
where money demanded is equal to money supplied.
• The goods and money market are related because income
affects our demand for money, and the interest rate
determines the amount of investment.
• There is an interest rate and a level of income at which both
the goods and money markets are in equilibrium.
• Fiscal and monetary policies affect the equilibrium amount
of goods and services provided in the economy.
What we know about macroeconomics.

A Note on AD–AS Curves
• Aggregate demand and aggregate supply curves resemble
“traditional” demand and supply curves but are very
different.
• An individual or market supply curve depicts the
quantities that are demanded or supplied for a given
price level ceteris paribus.
• At the economy-wide level, we are unable to fully make
use of the assumption that everything else is constant.
• Recall: the goods market and money market are
intimately related through the demand for money and the
interest rate.
Points to ponder about aggregate demand and aggregate supply curves.

First: Aggregate DemandDeriving the aggregate demand curve (one perspective).
AE
Y
r
M
s
45º
M
s
M
d
AE

AE
Y
45º
AE
r
M
s
M
d
M
s

P
Y
The aggregate demand (AD)
curve depicts the demand
for goods and services in the
economy at any given price
level.
We have shown that as the
price level rises, the interest
rate rises.
Consequently, the
equilibrium amount of goods
consumed in the economy
will fall.

P
Y
level.
rate rises.
Consequently, the
will fall.Y0
P0

P
Y
level.
rate rises.
Consequently, the
will fall.
P1
Y1 Y0
P0

P
Y
level.
rate rises.
Consequently, the
will fall.
P1
Y1Y2
P2

P
Y
level.
rate rises.
Consequently, the
will fall.Y3
P3
Y2
P2

P
Y
AD
level.
rate rises.
Consequently, the
will fall.

Next: Aggregate SupplyDeriving the aggregate supply curve.
P
Y
There are two things to
consider when deriving the
aggregate supply curve.
First, despite an overall
increase in the price level,
input prices may be ﬁxed in
the short run.
Second, at low levels of
production, capacity is
underutilized.
AD

P
Y
AD
At low levels of production,
there is room for an increase
in output that does not really
affect the price level.

P
Y
AD
At low levels of production,
there is room for an increase
in output that does not really
affect the price level.
As more capacity becomes
utilized, input prices also
begin to rise, and ﬁrms are
only able to produce more
by raising prices.
Hence, output can only
expand if the price level also
increases.

P
Y
AD
AS
This is the same as saying
that the economy can only
supply more goods and
services at higher price
levels.
In the short-run, this implies
that the aggregate supply
curve is upward sloping.
Note that the intersection
of AD and AS represents
the equilibrium price level
in the economy.

P
Y
The difference between
short- and long-run AS
curves has to do with input
prices, which are ﬁxed in the
short-run.
AS
What about the long-run?
AD

P
Y
AS
AD

P
Y
AS
Suppose we are at a high
level of output and there is
an increase in aggregate
demand.
AD

P
Y
AS
demand.
AD curve and the
equilibrium point shift
outward.
AD

P
Y
AD
AS
demand.
AD curve and the
outward.

P
Y
AD
AS
demand.
AD curve and the
outward.
However, over time the price
of inputs adjusts, causing
the AS curve to shift inward.

P
Y
AD
AS
Overall prices rise, but we
are back to the amount of
output originally produced.
demand.
AD curve and the
outward.
However, over time the price
of inputs adjusts, causing
the AS curve to shift inward.

P
Y
AD
In the long-run the AS curve
will be vertical.
(LR)AS
This merely demonstrates
that there is a limit to what
an economy can
conceivably produce.
For this reason, the long-run
AS curve can be considered
as an economy’s “potential
GDP.”

AS–AD Analysis
• If we hold the price level ﬁxed, then changes in other
variables will cause the aggregate demand and supply
curves to shift.
• Factors affecting aggregate demand:
• Money Supply (+)
• Government Spending (+)
• Taxes (–)
• Factors affecting aggregate supply:
• Input Prices/Costs (–)
• Economic Growth (+)
Taking stock of the interaction between aggregate demand and supply.

Policy Effects: Short-RunFiscal and monetary policy in the short-run.
P
Y
At lower levels of income,
expansionary policies are
more effective.
As the economy expands,
the price level rises.
However, this increase in
prices is smaller than the
expansion in output.
AD
ADLow

ADHigh
Policy Effects: Short-RunFiscal and monetary policy in the short-run.
P
Y
ADLow
AD
At higher levels of income,
economic expansion results
in much larger increases in
the price level.
This is mainly because the
economy is already
performing at or near
capacity.
Hence, expansionary
policies in such cases are
less effective.

Macroeconomics: Aggregate Demand and Supply

More Related Content

What's hot

Viewers also liked

Similar to Macroeconomics: Aggregate Demand and Supply

More from brianbelen

Recently uploaded

Macroeconomics: Aggregate Demand and Supply