Chapter 22Aggregate Demand

and Aggregate Supply

©2000 South-Western College Publishing

2

GDP Deflator

A price index that measures the overall changes in prices

of everything in GDP

3

Aggregate Demand Curve

Shows an inverse relationship between the overall price level and the quantity of real output that will be demanded at various price levels, ceteris paribus

4

Price Index

.95

The Aggregate Demand Curve

Exhibit 22 - 1

1.00

AD

$1,300 $1,500 $1,700

Real GDP (billions)

1.05

5

Why the Aggregate Demand Curve Slopes Downward

1. The real balance or wealth effect2. The substitution of foreign goods effect3. The constant nominal income effect

Exhibit 22 - 2

6

Wealth Effect, or Real Balances Effect

The change in the supply of real balances, which causes an increase or decrease in wealth, when the price level changes for a given supply of nominal money balances

7

Substitution-of-Foreign Goods Effect

When changes in the domestic price level cause consumers to substitute into relatively cheaper foreign goods or out of relatively more expensive foreign goods

8

Constant Nominal Income Effect

When changes in the price level necessarily cause the quantity demanded to change in the opposite direction to maintain the constant nominal purpose

9

Price Index

1.0

The Shift in Aggregate Demand Curve

Exhibit 22 - 3

A

ADAD'

$1,500 $2,000

Real GDP in billions

A'

10Exhibit 22 - 4

Money Supply Interest Rates

Government Spending & Taxes

Exchange Rates Capital Flows

U.S. Monetary Policy

U.S. Fiscal Policy

Foreign Policies & Developments

Interest Rates, Stock Prices, Exchange Rates,

Expected Inflation, Economic Outlook

Consumption Investment Government Net Exports

Aggregate Demand & Income

11

Aggregate Supply Curve

The curve graphically depicting the relationship between the overall price level and the quantity of real GDP that will be supplied at various price levels

12

Long-Run Equilibrium

When all prices, including wages, have fully adjusted to previous shifts in aggregate supply or demand and the flow of spending, saving, borrowing and lending continues until something else changes

13

Real Wage = nominal wage

overall price level

14

Short-Run Aggregate Supply Curve

Shows the direct relationship between the overall price level and the level of real output that will be supplied in response to changes in demand before full adjustment of relative price has taken place

15

Natural Level of Real Output

The level of real output that is consistent with long-run equilibrium given the economy’s quantity and productivity of the factors of production

16

Price Index

.95

Short Run Aggregate Supply

Exhibit 22 - 5

1.00

AD

$1,300 $1,500 $1,700

Real GDP (billions)

1.05

AD'

SRAS

AD''

B

A

C

17

Determinants of the Natural Level of Real Output

1. The economy’s capital stock2. Natural resources4. The labor force3. Technological know-how4. Institutional arrangements concerning the labor market and other input markets

Exhibit 22 - 6

18

Long-Run Aggregate Supply Curve

The vertical curve through the natural rate of output to which the economy will return in the long run, regardless of the price level

19

Price Index

1.0

The Long-Run Aggregate Real Supply

Exhibit 22 - 7

A AD

AD'

Real GDP

B1.10

LRAS

20

Price Index

1.00

Shifts in Short-Run Aggregate Supply

Exhibit 22 - 8

A

AD'

Real GDP in billions

1.10

LRAS

B

C

1.05

D

AD

SRAS''

SRAS'

SRAS

$1,500 $1,700

21

Demand-Pull Inflation

Sustained increases in the overall price level due to high levels of demand

22

Net Incurring of Financial Liabilities

The incurring of debt

23

Net Acquisition of Financial Assets

The purchasing of financial assets

24

Net Financial Investment

When the net acquisition of financial assets is greater than the net incurring of financial liabilities within a given sector

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Net Financial Deficit

When the net incurring of financial liabilities is greater than the net acquisition of financial assets within a given sector