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Chapter 27 - Aggregate Demand-Aggregate Supply

Aggregate demand is the total quantity of real GDP demanded, influenced by factors such as price level, expectations, and fiscal and monetary policy. The aggregate demand curve slopes downward due to the wealth and substitution effects, where higher price levels decrease real wealth and increase interest rates, leading to reduced consumption. Aggregate supply varies between the short run and long run, reflecting the relationship between the quantity of real GDP supplied and the price level.

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52 views18 pages

Chapter 27 - Aggregate Demand-Aggregate Supply

Aggregate demand is the total quantity of real GDP demanded, influenced by factors such as price level, expectations, and fiscal and monetary policy. The aggregate demand curve slopes downward due to the wealth and substitution effects, where higher price levels decrease real wealth and increase interest rates, leading to reduced consumption. Aggregate supply varies between the short run and long run, reflecting the relationship between the quantity of real GDP supplied and the price level.

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barira.wizdan
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Aggregate Demand &

Aggregate Supply
Aggregate Demand
• The quantity of real GDP demanded (Y) is the sum of real consumption
expenditure (C), investment (I), government expenditure (G), and exports (X )
minus imports (M).
• Y= C+I+G+X-M
• Buying plans depend on many factors. Some of the main ones are
1. The price level
2. Expectations
3. Fiscal policy and monetary policy
4. The world economy
Aggregate Demand
• Other things remaining the same, the
higher the price level, the smaller is the
quantity of real GDP demanded. This
relationship between the quantity of real
GDP demanded and the price level is
called aggregate demand.
• Aggregate demand is described by an
aggregate demand schedule and an
aggregate demand curve.
• The aggregate demand curve slopes
downward for two reasons:
■ Wealth effect
■ Substitution effects
Wealth and Substitution Effect
• Wealth Effect When the price level rises but other things remain the same, real wealth
decreases.
• If the price level rises, real wealth decreases. People then try to restore their wealth. To do
so, they must increase saving and, equivalently, decrease current consumption. Such a
decrease in consumption is a decrease in aggregate demand.
• Substitution Effects When the price level rises and other things remain the same, interest
rates rise.
• A rise in the price level decreases the real value of the money in people’s pockets and
bank accounts. With a smaller amount of real money around, banks and other lenders can
get a higher interest rate on loans.
• Faced with a higher interest rate, people and businesses delay cut back on spending.
• This substitution effect involves changing the timing of purchases of capital and consumer
durable goods and is called an intertemporal substitution effect—a substitution across
time. Saving increases to increase future consumption.
Changes in the Quantity of Real GDP
Demanded VS. Aggregate Demand
Changes in the Quantity of Real Changes in Aggregate Demand
GDP Demanded
• When the price level rises and other • A change in any factor that influences
things remain the same, the quantity buying plans other than the price level
of real GDP demanded decreases— a brings a change in aggregate demand
movement up along the AD curve. and shifts the AD curve. The main
• When the price level falls and other factors are
things remain the same, the quantity ■ Expectations
of real GDP demanded increases—a ■ Fiscal policy and monetary policy
movement down along the AD curve. ■ The world economy
Aggregate Supply

Aggregate supply is the relationship between the quantity of real


GDP supplied and the price level.

This relationship is different in the long run than in the short run.
Therefore we distinguish between the two time frame:
■ Long-run aggregate supply
■ Short-run aggregate supply

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