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Understanding Aggregate Demand and Aggregate Supply in Economics

Learn about Aggregate Demand and Aggregate Supply in economics, including their differences from regular demand and supply. Explore the determinants of Aggregate Demand and Supply and understand the inverse relationship between price levels and GDP. Discover how changes in these factors impact the economy.

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Understanding Aggregate Demand and Aggregate Supply in Economics

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  1. Aggregate Demand and Aggregate Supply

  2. Aggregate Demand • Not the same as “Demand” that you learned about in Chapter 3! • Aggregate Demand is the curve/schedule that shows the amount of Total goods/services desired (demanded) at various price levels by consumers, businesses, government, and foreign buyers • More of a generalization that “demand” as we learned it in chapter 3….

  3. Other difference between Demand and Aggregate Demand • The Graph….

  4. Why is there an inverse relationship between price level and GDP? • Wealth Effect - Higher prices = lower purchasing power, vice versa • Interest-Rate Effect - Higher prices = higher interest rates = less investment = less production (GDP) • Foreign Purchases Effect - Higher prices in U.S = decreased demand for domestic goods/services = increased imports, decreased net exports = decrease in GDP

  5. Determinants of Aggregate Demand Things that shift the AD curve: • Change in consumer spending • Consumer wealth • Consumer expectations • Household indebtedness • taxes • Change in Government spending

  6. Change in investment spending • Interest rates • Profit expectations on investment projects • Business taxes • Technology • Degree of excess capacity • Change in net export spending

  7. Aggregate Supply • Not the same as “supply” from Chapter 3! • AS is the curve/schedule showing the real gdp produced at each price level • The graph has three segments that are IMPORTANT to understand!!!! • Graph and Stinger…

  8. AS Curve

  9. Determinants of Aggregate Supply • Change in input prices - land, labor, capital, E.A. 2. Change in productivity = output / input 3. Change in legal-institutional environment • taxes/subsidies • Government regulations

  10. Increase in AD on the AS curve - • Depending on the range of the AS curve you are in, price level/Output will increase • The multiplier applies to this increase, but the multiplier is weakened by Price Level increases • Any increase in AD leads to an increase in Real GDP. However, the larger the increase in PL, the smaller the increase in Real GDP • In the intermediate and Vertical range, an increase in demand constitutes DEMAND-PULL INFLATION!!!

  11. What about when AD decreases? • Rule of thumb—prices and wages are “flexible” upwards but “inflexible” downwards. • This means that price level will gladly raise, but does not want to lower with a reduction in output….this is called the ratchet effect!

  12. Ratchet Effect

  13. So, as a result of the ratchet effect • When AD decreases, PL stays constant but production/output decreases…. • This explains why prices stay stable/high during times of economic recession (like now) • Get it????

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