# Aggregate Demand And Aggregate Supply

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```					Aggregate Demand And
Aggregate Supply

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 The aggregate demand curve is downward
sloping, specifying an inverse relationship
between the price level and the quantity
demanded of Real GDP, ceteris paribus.

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The Aggregate Demand Curve
(continued)
 Real GDP:
the value of the entire output produced
annually within a country’s borders, adjusted
for price changes.

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The Aggregate Demand Curve
(continued)
Year          Price of good Quantity      GDP            Real GDP
X             produced of
good X
(units)
1 (base year) \$ 10          100           \$ 10 x 100 =   \$ 10 x 100 =
\$ 1000         \$ 1000

2             \$ 12          120           \$ 12 x 120=    \$ 10 x 120=
\$ 1440         \$ 1200

3             \$ 14          140           \$ 14 x 140=    \$ 10 x 140=
\$ 1960         \$ 1400

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The Aggregate Demand Curve
(continued)
Aggregate Demand

Price Index      Quantity demanded of goods and
services (quantity demanded of real
GDP)
100              \$ 1200

110              \$ 1000

120              \$ 800

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Why Does The Aggregate Demand
Curve Slope Downward?
 Explained by the real balance effect, the
interest rate effect, and the international trade
effect.

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Real Balance Effect (Due To A Change In The Price
Level)…Monetary Wealth (Money Holdings)

Example:
A person who has \$ 50000 in cash.
Suppose the price level falls.
Causes the purchasing power of the person’s
\$ 50000 rises.

Exhibit 2 “Real Balance In Effect” Page 155.

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Interest Rate Effect (Due To A Change
In The Price Level)
Consider of a person who buy a fixed bundle of
goods each week. Suppose the price level falls,
increasing the purchasing power of the person’s
money. With more purchasing power, the
person can purchase fixed bundle with less
money. The person will save money more,
causes the supply of credit increases, which is
the interest rate drops. Households and businesses
borrow more, buying more goods, Real GDP rises.

Exhibit 2 Page 155 “Interest Rate Effect”
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 The change in foreign sector spending as the
price level changes.

Exhibit 2 Page 155 “International Trade
Effect.”

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A Change In The Quantity Demanded Of Real GDP
Versus A Change In Aggregate Demand

 A change in the quantity demanded of real
GDP is brought about by a change in the
price level.

Exhibit 3 Page 156 figure a.

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A Change In The Quantity Demanded Of Real GDP
Versus A Change In Aggregate Demand (continued)

 A change in aggregate demand is
represented as a shift in the aggregate
demand curve.

Exhibit 3 Page 156 figure b.

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Changes In Aggregate Demand: Shifts
 Aggregate demand changes when the
spending on goods and services changes.

 If spending increases at a given price level,
aggregate demand increases.

 If spending decreases at a given price level,
aggregate demand decreases.

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How Spending Components Affect
Aggregate Demand?
Let:
C = \$100
I = \$100
G = \$100
EX = \$50
IM= \$15
\$335 is spent on goods and services
Total expenditure on goods and services = C + I + G + NX

C increases, I increases, G increases, NX increases = Total
expenditure increases

C decreases, I decreases, G decreases, NX decreases = Total
expenditure decreases

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Factors That Can Change C, I, G, NX
 Consumption,
4 factors that can affect consumption, such
as:
1. Wealth
wealth increases…..consumption

wealth decreases…..consumption

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Factors That Can Change C, I, G, NX And Therefore
 Consumption,
4 factors that can affect consumption, such as:
2. Expectations about future prices and income
Expect higher future prices….consumption

Expect lower future prices….consumption

Expect higher future income….consumption

decreases

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Factors That Can Change C, I, G, NX And Therefore

 Consumption,
4 factors that can affect consumption, such
as:
3. Interest rate
Interest rate increases…..consumption

Interest rate decreases….consumption

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Factors That Can Change C, I, G, NX And Therefore

 Consumption,
4 factors that can affect consumption, such
as:
4. Income taxes
Income taxes increases…..consumption

Income taxes decreases…consumption

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Factors That Can Change C, I, G, NX And Therefore

 Investment
3 factors that can affect investment, such as:
1. Interest rate
Interest rate increases…..investment

Interest rate decreases…investment

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Factors That Can Change C, I, G, NX And Therefore

 Investment
3 factors that can affect investment, such as:
future sales….Investment

future sales….Investment

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Factors That Can Change C, I, G, NX And Therefore

 Investment
3 factors that can affect investment, such as:

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Factors That Can Change C, I, G, NX And Therefore
 Net export
2 factors that can affect investment, such as:
1. Foreign real national income
Foreign real national income
increases……Exports increases….Net export

Foreign real national income
decreases……Exports decreases….Net export

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Factors That Can Change C, I, G, NX And Therefore
 Net export
2 factors that can affect investment, such as:
2. Exchange rate
Dollar depreciates….US exports
increases and US imports decreases….US net

Dollar appreciates….US exports
decreases and US imports increases….US net

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Short Run Aggregate Supply
 Aggregate supply:
the quantity supplied of all goods and services
(Real GDP) at different price levels, ceteris
paribus.

Exhibit 6 Page 162

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Changes In Short Run Aggregate
Supply: Shifts In The SRAS Curve
 A change in quantity supplied of real GDP is
brought about by a change in the price level.

 The factors that can shift the SRAS curve
include:
- wage rates,
- prices of non labor inputs,
- productivity,
- supply shock.
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Wage Rate
 Exhibit 7 Page 164

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Prices Of Non Labor Inputs
 Almost the same as
Exhibit 7 Page 164

Increase the price non labor input….shift the
SRAS curve leftward.

Decrease the price non labor input….shift the
SRAS curve rightward.

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Productivity
 Increase in productivity….SRAS curve to shift
right.

Decrease in productivity….SRAS curve to
shift left.

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Putting AD and SRAS Together: Short
Run Equilibrium
 Exhibit 9 Page 167

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Thinking In Terms Of Short Run
Equilibrium Changes In The Economy
 Exhibit 10 Page 167

Figure b. An increase SRAS

Figure c. A decrease SRAS

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Long Run Aggregate Supply (LRAS)
 LRAS curve:
The LRAS curve is a vertical line at the level of
Natural Real GDP.

It represents the output the economy produces when
wages and prices have adjusted to their (final)
equilibrium levels and neither producers nor workers
have any relevant misperceptions.

Exhibit 13. Page 172

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 Natural real GDP:
the real GDP that it produced at the natural
unemployment rate. The real GDP that is
produced when the economy is in long run
equilibrium.

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Short Run Equilibrium, Long Run
Equilibrium, And Disequilibrium
 Exhibit 14 Page 172

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Case 1:
 Diagrammatically represent the effect on the
price level and real GDP in the short run of
each following:
a. A decrease in wealth.
b. An increase in wage rate.
c. A decrease in labor productivity.

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Case 2:
 Diagrammatically represent the following and
identify the effect on real GDP and the price
level in the short run:
a. An increase in SRAS that is greater than
b. A decrease in AD that is greater than the
increase in SRAS.
c. An increase in SRAS that is less than the
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Case 3:
 In the following figure, which part is
representative of each of the following:
a. A decrease in wage rates.
b. An increase in the price level.
c. A beneficial supply shock.
d. An increase in the price of non labor
inputs.

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Case 4:
 In the following figure, which of the points is
representative of each of the following:
a. The lowest real GDP.
b. The highest real GDP.
c. A decrease in SRAS that is greater than an

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