Principles of economics openstax chapter24

College
Principles
ofPhysics
Economics
ChapterSupply–Aggregate
# Chapter Title
Chapter 24 The Aggregate
Demand Model
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The housing market

Between 2000 and 2006, a housing bubble was formed. At the peak of the housing bubble, many people across the
country were able to secure the loans necessary to build new houses. Banks gave loans to many homeowners who did
not have enough income to qualify. In late 2006/early 2007, the housing bubble burst, causing prices to crash and
foreclosures to mount


The housing market

From the early 1990s up through 2005, the number of new single family houses sold rose steadily. In 2006, the
number dropped dramatically and this dramatic decline continued through 2011. In 2012, the number sold rose
a bit over previous years, but it was still lower than the number of new houses sold in 1990.


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MAJOR MARKETS IN THE ECONOMY

Product Market: The market in which goods and services are exchanged and in

which the equilibrium level of GDP is determined.

Money Market: The market in which financial instruments (money, bonds, and stocks)
are exchanged and in which the equilibrium rate of interest is determined.


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THE AGGREGATE DEMAND

Aggregate Demand (AD): The relationship between Real GDP and
the general level of price.

Each point on the AD shows a pair of income and price, which brings
both product and money markets to equilibrium.


THE AGGREGATE DEMAND

Aggregate Demand slopes down, showing that, as the price level rises, the amount of
total spending on goods and services declines.


Aggregate Supply

Aggregate Supply (AS) shows the relationship between total output supplied by all
firms and the general price level.

Aggregate Supply traces out the price and output decisions of all the markets and
firms.

Short-run Aggregate Supply
The shape of AS depends on productive capacity
of the economy.
AS is inverted L-shaped.

At low levels of output with high unemployment,
AS is fairly flat.

As the economy approaches full capacity, AS
gains a positive slope.

At full capacity, the AS becomes nearly vertical.


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AGGREGATE SUPPLY

AS slopes up because rising prices induce firms to produce more and earn
higher profits.

The “potential” GDP line shows the maximum that the economy can
produce with full employment of workers and physical capital. In the longrun AS becomes a vertical line.


Aggregate Supply

Aggregate equilibrium
AD = SRAS = LRAS at potential GDP (Y0)


Aggregate equilibrium

Short-run equilibrium is achieved at less than full-employment


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SHIFT IN AGGREGATE SUPPLY

a)

The rise in productivity causes the SRAS curve to shift to the right. Increases in AS,
lead to a greater level of output and a lower level of price.

b)

Rising input prices means a lower quantity will be produced so AS shift to the left from
AS0 to AS1. Decrease in AS results in reduced output, but a higher price.


SHIFT IN AGGREGATE SUPPLY


a)

Improvement in consumer or business confidence shifts AD to the right, getting the

economy closer to potential GDP. An increase in government spending or a cut in
taxes also shifts AD to the right.

b)

Worsening consumer or business confidence shifts AD to the left, getting the
economy farther from potential GDP. A decrease in government spending or higher
taxes also shifts AD to the left.

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SHIFT IN AGGREGATE DEMAND


SHIFT IN AGGREGATE DEMAND


SHIFT IN AGGREGATE DEMAND

Whether the economy is in a recession is illustrated in the AD-AS model by how close the
equilibrium is to the potential GDP. In this example, an increase in AD can get the economy closer to
full employment.


Effect of aggregate demand policy

An increase in AD when the economy is operating at low levels of output is likely to result in an increase in output with a
small increase in the price level.
As the economy approaches full-employment, firms respond to further increases in AD by raising prices to cover higher
production costs.