Aggregate Demand And Aggregate Supply

Presented By
Maryam Arshad
Naveera Arooj
Nazish Khan

Contents
Aggregate demand
Aggregate Supply
The Classical Theory

The Keynesian Theory

Fiscal policy
Monetary Policy

Aggregate demand and supply

Aggregate Demand
The total amount of goods and services demanded in
the economy at a given overall price level and in a
given time period. It is represented by the aggregatedemand curve, which describes the relationship
between price levels and the quantity of output that
firms are willing to provide. Normally there is a
negative relationship between aggregate demand and
the price level. Also known as total spending

Aggregate Demand Curve

The aggregate demand curve represents the total quantity of
all goods (and services) demanded by the economy at different
price levels. An example of an aggregate demand curve is given
in Figure.

Contd
The vertical axis represents the price level of all final

goods and services. The aggregate price level is

measured by either the GDP deflator or the CPI. The
horizontal axis represents the real quantity of all goods
and services purchased as measured by the level of real
GDP. Notice that the aggregate demand curve, AD, like
the demand curves for individual goods, is downward
sloping, implying that there is an inverse relationship
between the price level and the quantity demanded of
real GDP.

FORMULA
The sum of all expenditure in the economy over a

period of time
Macro concept WHOLE economy
Formula:
AD = C+I+G+(X-M)
C= Consumption Spending
I = Investment Spending
G = Government Spending
(X-M) = difference between spending on imports and
receipts from exports (Balance of Payments)

Reasons
The reasons for the downward-sloping aggregate

demand curve are different from the reasons given for

the downward-sloping demand curves for individual
goods and services
. The first is the wealth effect. The aggregate demand
curve is drawn under the assumption that the
government holds the supply of money constant. One
can think of the supply of money as representing the
economy's wealth at any moment in time. As the price
level rises, the wealth of the economy, as measured by
the supply of money, declines in value because the
purchasing power of money falls.

REASONS (Contd)
A second reason is the interest rate effect. As the price

level rises, households and firms require more money

to handle their transactions. However, the supply of
money is fixed. The increased demand for a fixed
supply of money causes the price of money, the
interest rate, to rise. As the interest rate rises, spending
that is sensitive to rate of interest will decline.
The third and final reason is the net exports effect. As
the domestic price level rises, foreign-made goods
become relatively cheaper so that the demand for
imports increases.

Changes in aggregate demand

Changes in aggregate demand are represented by shifts
of the aggregate demand curve. An illustration of the
two ways in which the aggregate demand curve can shift
is provided in Figure.

Contd.
A shift to the right of the aggregate demand curve.

from AD1 to AD2, means that at the same price levels

the quantity demanded of real GDP has increased. A
shift to the left of the aggregate demand curve, from
AD1 to AD3, means that at the same price levels the
quantity demanded of real GDP has DECREASE 4
Changes in aggregate demand are not caused by
changes in the price level. Instead, they are caused by
changes in the demand for any of the components of
real GDP.

Aggregate supply

Aggregate Supply
Aggregate supply is the total supply of all goods and

services in the economy.

The aggregate supply (AS) curve is a graph that shows
the relationship between the aggregate quantity of
output supplied by all firms in an economy and the
overall price level.
The aggregate supply curve is not a market supply
curve or the sum of all the individual supply curves in
the economy

Aggregate Supply Curve

In the short run, the aggregate supply curve (the

price/output response curve) has a positive slope.

Contd.
The total supply of goods and services produced within
an economy at a given overall price level in a given
time period.

Aggregate Supply and Aggregate Demand

Complete AS-AD Model

Changes in aggregate supply

Changes in aggregate supply are represented by shifts of the aggregate supply
curve. A shift to the right of the SAS curve from SAS1 to SAS2 of the LAS curve
from LAS1 to LAS2 means that at the same price levels the quantity supplied of
real GDP has increased.
A shift to the left of the SAS curve from SAS1 to SAS3 or of the LAS curve from
LAS1 to LAS3 means that at the same price levels the quantity supplied of real
GDP has decreased.

Shifts of the aggregate demand curve

A shift to the right of the aggregate demand
curve. from AD1 to AD2, means that at the
same price levels the quantity demanded of
real GDP has increased. A shift to the left of the
aggregate demand curve, from AD1 to AD3,
means that at the same price levels the quantity
demanded of real GDP has decreased.

Shift factors of aggregate

supply
IN SHORT RUN:
a. Changes in input prices
b. Changes in expectation of inflation
c. Excise and sales duty
d. Productivity
e. Import prices

 IN LONG RUN
a. Capital
b. Available recources
c. Growth compatible institutes
d. Technological institutes
e. Entrepreneurship

The Classical Theory

The fundamental principle of the classical theory is that the
economy is self-regulating.
If there is increases money supply then there is no effect on
economy because money is only the medium of exchange.

Key points of classical theory

a. Fundamental princile is that the economy is self
b.
c.
d.
e.
f.

regulating
Economys recources are fully employed
It focuses on long run
There is no immediate effect
There are some invisible hands
Money is only a medium of exchange

 The economy is always at or near the natural level of

GDP is backed by two beliefs:

a. Says law
b. Prices,wages and interst are flexible

ACCORDING TO SAYS LAW:

W hen an economy produces a certain level of GDP it
can
also generates the income needed to purchase
that level of GDP
OR
Supply creates its own demand

The Keynesian Theory

Keynes's theory of the determination of

equilibrium real GDP, employment, and prices

focuses on the relationship between aggregate
income and expenditure.
Keynesian says says money is not only the
medium of exchange, but it is also an store of
value we can change deflation and inflation by
increase and decrease money supply.

Key points
a. Economy Is not always self regulating
b. Economy is not fully employed
c. It focuses on short run
d. There is no self adjustment
e. Money is not only a medium of exchange
f.

First create demand then make supply

The Aggregate Demand-Aggregate Supply model is a

macroeconomic model that explains price level and
output through the relationship of aggregate demand
and aggregate supply. It is based on the theory of John
Maynard Keynes presented in his work The General
Theory of Employment, Interest, and Money.

Temporary or short run changes in input prices

and resource costs will shift the SRAS curve
without changing the full employment level of
real GDP and shifting the LRAS curve.

Difference between fiscal and monetary

policy?
Monetary policy is typically implemented by a
central bank, while fiscal policy decisions are set
by the national government. However, both
monetary and fiscal policy may be used to
influence the performance of the economy in the
short run.

Fiscal Policy
Government spending policies that influence

macroeconomic conditions. These policies affect tax

rates, interest rates and government spending, in an
effort to control the economy.

Fiscal policy
Fiscal Policy concerns the use of changes in the
amount of government spending, G and taxation T to
influence the national economy. This policy can affect
both Aggregate Demand (AD) and Aggregate Supply
(AS), though it is worth noting that the affect on AD is
much more direct and immediate, whereas AS is
affected through indirect means over a greater period
of time. It is also just about impossible to isolate the
two effects - any change in fiscal policy will ultimately
affect both AD and AS.

Fiscal Policy Goals

Stability- unemployment, inflation
Equity - inequality, fairness
Sustainability resource use, balance
Growth- per capita GDP, living standard

Monetary Policy
The actions of a central bank, currency board or other
regulatory committee that determine the size and rate of
growth of the money supply, which in turn affects interest
rates. Monetary policy is maintained through actions such as
increasing the interest rate, or changing the amount of money
banks need to keep in the vault (bank reserves).

Monetary Policy
Monetary policy is strongly supported by the Chicago
school of economics and is a demand side policy
designed to improve the economy by adjusting interest
rates and money demand. In the modern world were
fiscal policy is used increasingly less monetary policy,
as controlled by the central bank, has become the
preferred way to make short term improvements to the
economy.