Isues in economics today 6th by guell chapter08

Chapter 08
Aggregate
Demand and
Aggregate
Supply

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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
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Aggregate Demand
• Aggregate Demand: the

amounts of real domestic output
which domestic consumers,
businesses, governments, and
foreign buyers collectively will
desire to purchase at each
possible price level

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Figure 1 Aggregate Demand
PI

AD

RGDP
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Why Aggregate Demand is

Downward Sloping
• Real Balances Effect
• Because higher prices reduce real spending
power, prices and output are negatively
related.

• Foreign Purchases Effect
• When domestic prices are high, we will export
less to foreign buyers and we will import more
from foreign producers. Therefore higher
prices leads to less domestic output.

• Interest Rate Effect
• higher prices lead to inflation which leads to
less borrowing and a lowering of RGDP
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Aggregate Supply
• Aggregate Supply: the level
of real domestic output
available at each possible price
level

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Figure 2 The Aggregate Supply
Curve AS
PI

Classical
Range

Intermediate
Range
Keynesian Range

RGDP
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The Ranges of AS
• Keynesian Range
• Large amounts of unemployment make it so

that increases in aggregate demand have no
affect on wages or prices.

• Classical Range
• Full employment makes it so that increases in
aggregate demand only increase wages or
prices.

• Intermediate Range
• Some sectors of the economy reach full
employment more quickly than others.

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Variables that Shift Aggregate
Demand
•
•
•
•
•

Taxes
Interest Rates

Confidence
Strength of the Dollar
Government Spending

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Determinants of AD
Variable

GDP
Compone
nt C,I,G,X

Effect of an
increase on
AD

Effect of a
decrease on
AD

Taxes

C,I

Decrease
so
AD <=

Increase so
AD =>

Interest
Rates

C,I

Decrease
so
AD <=

Increase so
AD =>

Confidence

C,I

Increase so
AD =>

Decrease
so
AD <=

Strength of
the Dollar

X
Decrease
Increase so
(exports- so
AD =>
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Figure 3 AD Increases
PI

AS

PI’

PI*
AD’
AD

RGDP*
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RGDP’

RGDP

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Figure 4 AD Decreases
PI

AS

PI*
PI’
AD
AD’
RGDP’
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RGDP*

RGDP

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Variables that Shift AS
• Input Prices
• Productivity
• Government Regulation

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Determinants of AS
Variable

Effect of an
Increase on
AS

Input Prices Decrease
so
AS
Productivity Increase so
AS
Governmen Decrease
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Effect of an
Decrease on

AS

Increase so
AS
Decrease
so
AS
Increase so

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Figure 5 Increase in AS
PI

AS
AS’

PI*
PI’
AD

RGDP*
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RGDP’

RGDP

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Figure 6 Decrease in AS
PI

AS’
AS

PI’
PI*
AD
RGDP’
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RGDP*

RGDP

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Causes of Inflation
• Demand Pull Inflation:
inflation caused by an increase
in aggregate demand
• Cost Push Inflation: inflation
caused by a decrease in
aggregate supply

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Government Influence:
Aggregate Demand
• Government can influence
economic activity with
aggregate demand side
policies affecting:
• Taxes
• Government Spending
• Interest Rates
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Government Influence:
Aggregate Supply
• Government can influence economic
activity with aggregate supply side policies
affecting
• input costs (labor and wage)
• reducing regulation
• Increase incentives to
• Work
• Take Risks

• The actions are call Supply Side
Economics
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