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Chapter Outline

• Aggregate Demand
• Aggregate Supply
• Shifts in Aggregate Demand and Aggregate
Supply
• Causes of Inflation
• Supply-Side Economics
• How the Government Can Influence (but
probably not control) the Economy
The Aggregate-Demand Curve
• Curve that shows the quantity of goods and
services that households, firms, the
government, and customers abroad want to
buy at each price level.
Aggregate Demand Curve

Price
Level

P1

P2
1. A
decrease in
the price Aggregate
level… Demand

0
Y1 Y2 Quantity of
Output
2….increases the quantity of goods and
services demanded
Why the Aggregate-Demand Curve
Slopes Downward
1. The Wealth Effect:
(The Price Level and Consumption)
2. The Interest-Rate Effect:
(The Price Level and Investment)
3. The Exchange-Rate Effect:
(The Price Level and Net Export)
Why Aggregate-Demand Curve Might Shift

1. Shifts Arising from Changes in Consumption


2. Shifts Arising from Changes in Investment
3. Shifts Arising from Changes in Government
Purchases
4. Shifts Arising from Changes in Net Exports
Shifts in the Aggregate Demand Curve
to the Right
Price
Level

P1

AD2

Aggregate
Demand
0
Y1 Y2 Quantity of
Output
2….increases the quantity of goods and
services demanded
Shifts in the Aggregate Demand Curve
to the Left
Price
Level

P1

AD1
AD2
0
Y2 Y1 Quantity of
Output
2…Decreases the quantity of goods and
services demanded
The Aggregate-Supply Curve
• A Curve that shows the quantity of goods and
services that firms choose to produce and sell
at each price level.

Natural Level of Output


• The production of goods and services that an
economy achieves in the long run when
unemployment is at its normal rate.
The Aggregate-Supply Curve in the
Short Run
Price
Level Short run
aggregate
supply

P1

P2
1. A
decrease in
the price
level…

0
Y2 Y1 Quantity of
Output
2….Reduces the quantity of goods and
services supplies in the short run.
The Aggregate-Supply Curve in the
Long Run
Price
Level Long -Run
aggregate
supply
P1

P2

1. A change 2….Does not affect the quantity of goods


in the price and services supplied in the Long-run.
level…

0
Natural Level Quantity of
of Out put Output
Why the Long-Run Aggregate-Supply
Curve Might Shift
• Shifts Arising from Changes in Labor
• Shifts Arising from Changes in Capital
• Shifts Arising from Changes in Natural
Resources
• Shifts Arising from Changes in Technological
Knowledge
Using Aggregate Demand and Aggregate Supply
to Depict Long-Run Growth and Inflation
2….and growth in the Long-Run
money supply shifts Aggregate
aggregate demand… Supply,

LRAS1990 LRAS2000 LRAS2010


Price
Level

1. In the Long run,


technological progress shifts
long-run Aggregate supply…

4….and P2010
ongoing
inflation P2010 Aggregate
P2010
Demand, AD2010

AD2000

AD1990
0 Y1990 Y2000 Y2010
Quantity of
Output
3….leading to growth
in output
Why the Aggregate-Supply Curve Slopes
Upward in the Short Run
• Macro economists have proposed three
theories for the upward slope of the short-run
aggregate-supply curve.
1. The Sticky-Wage Theory
2. The Sticky-Price Theory
3. The Misperceptions Theory
Why the Short-Run Aggregate-Supply
Curve Might Shift
• Shifts Arising from Changes in Labor:
• Shifts Arising from Changes in Capital:
• Shifts Arising from Changes in Natural
Resources:
• Shifts Arising from Changes in Technology :
• Shifts Arising from Changes in the Expected
Price Level:
The Long-Run Equilibrium

Price Long -Run


Level aggregate Short run
supply aggregate
supply

Equilibrium A
Price

Aggregate
Demand

0
Natural Level
Quantity
of Out put
of Output
Four Steps for Analyzing Macroeconomic Fluctuations

1. Decide whether the event shifts the aggregate-


demand curve or the aggregate-supply curve (or
perhaps both)
2. Decide the direction in which the curve shifts.
3. Use the diagram of aggregate demand and
aggregate supply to determine the impact on
output and the price level in the short run.
4. Use the diagram of aggregate demand and
aggregate supply to analyze how the economy
moves from its new short-run equilibrium to its
new long-run equilibrium.
The Effects of a Shift in Aggregate
Demand
2….causes output to fall in the
short run…

Price Long -Run Short run AS1


aggregate
Level aggregate
Supply,
supply AS2

3….but over time, the


short-run aggregate-
supply curve shifts…
P1 A
1.A decrease in

P2 B Aggregate
demand…

C Aggregate
P3
Demand,
AD1

AD2
0 Y2 Y1
Quantity of
4…. and output returns Output
to its natural level
The Effects of a Shift in Aggregate
Supply
Short run 1, an adverse shift
aggregate in the short-run
Price Long -Run Supply, aggregate-supply
Level aggregate AS2 curve…
supply AS1

B
3…. And P2 A
the price
level to rise, P1

Aggregate
Demand,
0 Y2 Y1
Quantity of
Output
2….causes output to fall…
Stagflation 1.When short-run
aggregate supply
falls…

AS2
Price Long -Run Short run
aggregate
Level aggregate
Supply,
supply AS1

P3 C 2….policymakers can
accommodate the shift by
P2 A expanding aggregate
demand…
3….Which causes P1
the price level to
rise further…
AD2

AD1 Aggregate
Demand,
0
Natural Level Quantity of
of Out put Output
4…. But keeps output at
its natural level,