AGGREGATE
DEMAND AND
SUPPLY
Nguyễn Việt Hưng
OBJECTIVES
Economic fluctuations
Aggregate demand
Aggregate supply
• Long-run
• Short-run
Causesof economic
fluctuation
2
ECONOMIC FLUCTUATIONS
3
ECONOMIC FLUCTUATIONS
4
ECONOMIC FLUCTUATIONS
5
ECONOMIC FLUCTUATIONS
A sequence of economic activity typically
characterized by recession, fiscal recovery,
growth, and fiscal decline
Fluctuations in the economy are often
called the business cycle (growth, slow
down, recession, recovery)
6
><
expansion
Recession a period of declining incomes and rising
unemployment
Expansion an increase in the level of economic activity,
and of goods and services available in the market place.
Depression a severe recession
7
3 KEY FACTS
ABOUT ECONOMIC FLUCTUATIONS
• economic fluctuations are
Fact 1 irregular and unpredictable
• most macroeconomic
Fact 2 quantities fluctuate together
• as output falls,
Fact 3 unemployment rises
8
Model of aggregate demand and aggregate supply
• the model that most economists use to explain short-run
fluctuations in economic activity around its long-run trend
Aggregate
demand curve
Short-run
AS/AD model aggregate
supply curve
(SRAS)
Aggregate
supply curve
Long-run
aggregate
supply curve
(LRAS)
9
THE AGGREGATE DEMAND CURVE
Aggregate demand curve tells us the quantity of all goods
and services demanded in the economy at any given price
level
AD = C+I+G+(X-M)
10
How does price affect aggregate demand?
Higher overall price level makes
total quantity of domestic goods
and services demanded decrease
The Wealth Effect
The Interest-Rate Effect
The International Trade Effect
11
How does price affect aggregate demand?
The Wealth Effect
Price level falls Price
level
Consumers feel P1
Ag
more wealthy
g
re
g at
ed
P2
em
an
d
They spend more
0 Y1 Y2
Quantity of
output
Quantity of goods
and services
demanded rises
12
How does price affect aggregate demand?
The Interest-Rate Effect
Price
level
Price level falls
P1
Ag
Households hold less money
g
re
g at
and lend some out
ed
P2
em
an
d
They convert their money into
interest-bearing assets
0
Y1 Y2
Quantity of
output
Interest-rate falls
Quantity of goods
Firms want to borrow more and and services
spend more in investment goods demanded rises
13
How does price affect aggregate demand?
The International Trade Effect : 2 cases
U.S Price
U.S goods Both Quantity
level falls U.S net
relatively less Americans of goods
relative to exports
expensive and foreigners and services
foreign price rise
than foreign buy more demanded
level (exchange-
goods U.S goods rises
rate doesn’t
change)
Real exchange
U.S price U.S interest rate
level fall rate falls depreciates
14
Which other factors shift the Aggregate Demand
curve?
Consumption
1. Pessimistics
Investment /Optimistics
Changes Aggregate
in 2. Policies demand curve
Government Fiscal/monetary/exchange shifts
Purchases rate/trade policies
3. World
Net Exports economy
15
Shifts Arising from Consumption
Example
A tax cut makes people feel Price level
more wealthy and happy
They spend more
A B
P
Greater quantity of goods
and services demanded at
any given price level
Aggregate demand curve Y1 Y2 Quantity of
output
shifts to the right
16
RV E
YC U
P PL
E S U
G AT
GRE
E A G
TH
17
THE AGGREGATE-SUPPLY CURVE
Tells us the total quantity of goods and
services that all firms in the economy
produce and sell at any given price
level.
Assumption:
The amount of factors of production
(capital, technology, and labor
force) is given
18
THE AGGREGATE-SUPPLY CURVE
labor
REAL GDP
capital Available (potential
technology output)
Natural resources
19
THE AGGREGATE-SUPPLY CURVE
When prices go up, firms produce more
only for a while (short-run)
When prices go up, firms could not
produce more than the potential level
(long-run)
• Because factors of production are assumed being fixed
20
HOW THE SHORT RUN DIFFERS FROM
THE LONG RUN
Short run Long run
• a period of time in which prices • a period of time in which prices
are not flexible and information is are completely flexible and
not well-perceived. information is well-perceived
• Classical theory of money
• Keynesian theory neutrality
21
IN THE LONG RUN
-The long-run aggregate supply curve
reflects the classical model of the
economy
The LRAS curve is vertical
at the potential output. That
means the price level does
not affect these long-run
determinants of real GDP.
(only in the long run)
22
WHEN DOES THE LRAS CURVE SHIFT
labor
Shifts
capital arising Technologica
l Knowledge
from...
Natural
Resources
23
THE AGGREGATE-SUPPLY
CURVE IN THE SHORT RUN
Why the aggregate-supply curve
slopes upward in the short run?
The price level has positive
impact on the quantity
produced
24
WHY THE AGGREGATE-SUPPLY CURVE SLOPES
UPWARD IN THE SHORT RUN?
The Sticky-Wage Theory:
Nominal wages are slow to adjust, or are “sticky”,
in the short run.
Wages do not adjust immediately to the price
level, a lower price level makes employment and
production less profitable, which induces firms to
reduce the quantity of goods and services
supplied.
25
WHY THE AGGREGATE-SUPPLY CURVE SLOPES
UPWARD IN THE SHORT RUN?
The Misperceptions Theory:
Suppliers respond to changes in the perceived
relative prices, and this respond leads to an upward-
sloping aggregate-supply curve.
A lower general price level causes misperceptions
about relative prices, and these misperceptions
include suppliers decrease the quantity of goods
and services supplied.
26
WHEN DOES SHORT-RUN AS
CURVE SHIFT?
Change in input prices (wages and materials)
Change in the state of technology
Taxes, subsidies, or economic regulations
Change in expected price level
27
TWO CAUSES OF
ECONOMIC FLUCTUATIONS
The effects of a shift in
aggregate demand
The effects of a shift in
aggregate supply
28
DEMAND SHOCK
Price
Firms are pessimistic
Level
about the future of
the economy and
reduce investment
Aggregate
supply
Aggregate
supply
Equilibrium
price level
Aggregate
demand
0 Equilibrium Quantity of
output Output
29
SUPPLY SHOCK
Price
Level
Aggregate
supply
An increase in oil price
causes input costs of
Equilibrium firms to increase.
price level
Aggregate
demand
0 Equilibrium Quantity of
output Output
30
