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Chapter 22Aggregate Demand
and Aggregate Supply
©2000 South-Western College Publishing
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2
GDP Deflator
A price index that measures the overall changes in prices
of everything in GDP
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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
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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
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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
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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
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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
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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
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Price Index
1.0
The Shift in Aggregate Demand Curve
Exhibit 22 - 3
A
ADAD'
$1,500 $2,000
Real GDP in billions
A'
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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
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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
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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
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Real Wage = nominal wage
overall price level
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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
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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
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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
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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
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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
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Price Index
1.0
The Long-Run Aggregate Real Supply
Exhibit 22 - 7
A AD
AD'
Real GDP
B1.10
LRAS
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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
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21
Demand-Pull Inflation
Sustained increases in the overall price level due to high levels of demand
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22
Net Incurring of Financial Liabilities
The incurring of debt
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Net Acquisition of Financial Assets
The purchasing of financial assets
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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