Chapter 9

Macroeconomic
Equilibrium:
Aggregate
Demand and
Supply
Economics, 7th Edition
Boyes/Melvin
 The Business Cycles
• Aggregate demand = total spending in the
economy at alternative price levels.
• Aggregate supply = total output of the economy
at alternative price levels.
• Changes in aggregate demand and supply
cause the equilibrium price level and real GDP
to change resulting in business cycles.

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 Aggregate Demand, Aggregate
Supply, and Business Cycles

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 Aggregate Demand
and Business Cycles

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 Demand Pull Inflation
• Demand Pull inflation typically occurs
during a “boom.”

• In 2005 at the peak of the real estate

boom, the median price of a home in
California rose to $500,000, more than
twice the national price.

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 Factors that Affect AD

AD = C + I + G + NX
• Consumption • Government Spending
– Income • Net Exports
– Wealth – Domestic & Foreign Income
– Expectations
– Domestic & Foreign Prices
– Exchange Rates
– Demographics – Government Policy
– Taxes
• Investment
– Interest Rates
– Technology
– Cost of Capital Goods
– Capacity Utilization

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 Why the Aggregate Demand
Curve Slopes Downward

• The reasons for its downward slope are

price-level effects:
– Wealth Effect (Real Wealth/Real Balances)
– Interest Rate Effect
– International Trade Effect (Substitution)

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 Interest Rate Effect

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 Expectations

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 Aggregate Supply Curve
Shows the amount of real GDP produced
at different price levels

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 Why the Aggregate
Supply Curve Slopes Upward

• Along the aggregate supply curve,

everything is held fixed except the price
level and output. The price level is the
price of output, thus the positive slope.

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 Shape of Short-run AS (SRAS)
• In the short-run, the capital stock is held
constant.
• Increasing the number of workers
increases output, but at a diminishing rate.
• Diminishing returns manifest as an ever-
steeper SRAS curve.

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 The Shape of the
Short-Run Aggregate Supply Curve

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 The Shape of
Long-run AS (LRAS)

• Resource costs are NOT fixed.

• The amount of capital is NOT fixed.
• In the long-run, AS is set by the
production possibilities curve—the
capacity of the economy, and is not
affected by prices, hence is vertical.

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 The Shape of the
Long-Run Aggregate Supply Curve

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 Determinants of
Aggregate Supply: Resource Prices

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 Determinants of
Aggregate Supply: Expectations

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 Shifting the Long-Run
Aggregate Supply Curve

Growth occurs as the

labor force and the
capital stock grow, as
technological
innovation improves
production efficiency.

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 Aggregate
Demand and
Aggregate Supply
Equilibrium

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 Aggregate Demand
and Supply Equilibrium

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