AGGREGATE DEMAND & AGGREGATE SUPPLY

(1) AGGREGATE DEMAND

1) DEFINITION: IT IS ACHEDULE OR CURVE THAT SHOWS THE

AMOUNTS OF REAL OUTPUT (REAL GDP) THAT BUYERS
COLLECTIVELY DESIRE TO PURCHASE AT EACH POSSIBLE PRICE
LEVEL.

2) AGGREGATE DEMAND CURVE: SLOPES DOWNWARD

BECAUSE OF:

1. REAL-BALANCES EFFECT (RELATED T CONSUMPTION)

2. INTEREST-RATE EFFECT (RELATED TO INVESTMENT)
3. FOREIGN TRADE EFFECT (RELATED TO NET EXPORTS)

3) CHANGES IN AGGREGATE DEMAND (DETERMINANTS):

(Fig. 10.2)

1. CONSUMER SPENDING: (C)

(1) CONSUMER WEALTH
(2) CONSUMER EXPECTATIONS
(3) HOUSEHOLD DEBT
(4) PERSONAL TAXES
(5) REAL INTEREST RATES)

2. INVESTMENT SPENDING: (I)

(1) REAL INTEREST RATES
(2) EXPECTED RETURNS): (FOUR FACTORS)
1) EXPECTATIONS ABOUT FUTURE
2) TECHNOLOGY
3) DEGREE OF EXCESS CAPACITY
4) BUSINESS TAXES

3. NET EXPORT SPENDING (Xn)

(1) NATIONAL INCOME ABROAD
(2) EXCHANGE RATES
(2) AGGREGATE SUPPLY

1) DEFINITION: IS A SCHEDULE OR A CURVE SHOWING THE

LEVEL OF REAL DOMESTIC OUTPUT THAT FIRMS WILL PRODUCE
AT EACH PRICE LEVEL.

2) AGGREGATE SUPPLY IN THE SHORT RUN: SLOPES UPWARD

3) AGGREGATE SUPPLY IN THE LONG RUN: VERTICAL AT

POTENTIAL GDP. INPUT PRICES ARE FULLY RESPONSIVE TO
CHANGES IN THE PRICE LEVEL.

4) CHANGES IN AGGRGATE SUPPY (DETERMINANTS):

(Fig. 10.6)

1. INPUT PRICES (DOMESTIC & IMPORTED)

TOTAL INPUT COST

PER-UNIT PRODUCTION COST = ------------------------------
UNITS OF OUTPUT
2. PRODUCTIVITY
TOTAL OUTPUT
PRODUCTIVITY = ----------------
TOTAL INPUT

3. LEGAL-INSTITUTIONAL ENVIRONMENT:

1) BUSINESS TAXES AND SUBSIDIES

2) GOVERNMENT REGULATION
3) MARKET POWER (Unions versus Management, Market
Structure and Monopolistic Power)

(3) EQUILIBRIUM GDP

1) INCREASE IN AD: DEMAND-PULL INFLATION

2) DECREASE IN AD: Recession & Cyclical Unemployment:

Prices tend to be “sticky” or inflexible downward because of:

1. FEAR OF PRICE WARS

2. MENUE COST
3. WAGE CONTRACTS
4. MORALE, EFFORT, AND PRODUCTIVITY
5. MINIMUM WAGE
 3) DECREASE IN AS: COST-PUSH INFLATION

4) INCREASE IN AS: Full Employment with Price-Level Stability

(4) FROM THE SHORT RUN TO THE LONG RUN

1) SHORT-RUN AS: UPWARD-SLOPING

2) LONG-RUN AS: VERTICAL AT POTENTIAL GDP

3) LONG-RUN EQUILIBRIUM IN THE AD-AS MODEL

(5) EQUILIBRIUM VERSUS FULL-EMOLOYMENT GDP

1) RECESSIONARY GAP

2) INFLATIONARY GAP

STUDY QUESTIONS # 1, 4, 5, 6, 12, and 13