Aggregate Demand Aggregate Supply Chapter 11 Introduction ADAS

Aggregate Demand & Aggregate Supply Chapter 11

Introduction AD-AS model is a variable price model. Aggregate Expenditures in chapters nine & ten assumed constant price level. AD-AS Model provides insight into inflation, unemployment, & economic growth

Aggregate Demand (AD) Shows various amounts of real domestic output at various price levels that both foreign and domestic buyers will purchase at each level. Inverse relationship between price level & domestic output No longer will substitution and income effects apply. Only works for individual product demand, not aggregates.

Reasons for the Inverse Relationship Real Balances Effect – When price level falls, purchasing power rises and spending increases Interest Rate Effect – Decline in price level lowers interest rates which increases certain types of spending Foreign Purchases Effect – When price level falls, US prices decrease relative to foreign prices, export spending increases while import spending decreases

Deriving AD-curve from Aggregate Expenditures Model Both measure Real GDP on Horizontal Axis As price level increases, wealth decreases, interest rates rise, net exports fall, equilibrium GDP decreases (moves downward along the curve)

Determinants of Aggregate Demand for Consumers Changes in consumer spending are affected by several factors: Consumer wealth Consumer expectations Consumer debt Taxes

Determinants of Aggregate Demand for Businesses Changes in investment spending caused by: Interest Rates Profit Expectations Business Taxes Technology Excess capacity (unused capital)

Government Spending Increased Government purchases increase aggregate spending so long as taxes remain at the same level Example – Military cutbacks push the aggregate model to the left

Net Exports Changes in net export spending not related to price level: Income abroad Exchange Rates

Aggregate Shifts & the Demand Model Change in determinants = change in aggregate expenditures Multiplier effect still applies if price level remains constant Shift of AD Curve = initial change in spending x multiplier

Aggregate Supply Shows level of domestic output firms will produce at each price level Positive relationship between real output and price level

3 Segments of Agg. Supply Horizontal – Price level constant. Substantial output variation, economy far below full-employment output level (recessionary) Upsloping (intermediate) range – price level rising, resource markets near full employment raising production costs Vertical – assumed full capacity, natural unemployment achieved

Aggregate Supply Determinants Resource Availability (factors of production) Prices of imported resources Market power in certain industries (OPEC) Productivity changes Government regulation Business Taxes

Equilibrium The point of intersection between the aggregate demand aggregate supply Equilibrium will shift when you have changes in demand determinants As price level rises, multiplier effect is weakened