Transcript Document
Economics: Principles and
Applications, 2e
by Robert E. Hall &
Marc Lieberman
© 2001 South-Western, a division of Thomson Learning
Aggregate Demand
and Aggregate Supply
© 2001 South-Western, a division of Thomson Learning
The Aggregate
Demand Curve
•The Price Level and the Money Market
•Deriving the Aggregate Demand Curve
•Understanding the AD Curve
•Movements Along the AD Curve
•Shifts of the AD Curve
© 2001 South-Western, a division of Thomson Learning
The Aggregate
Demand Curve
A rise in the price level causes a decrease in
equilibrium GDP.
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The Aggregate
Demand Curve
Aggregate Demand (AD) Curve
A curve indicating equilibrium GDP at each
price level.
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The Aggregate
Demand Curve
The AD curve represents more than just a
behavioral relationship between two variables.
Each point on the curve represents a shortrun equilibrium in the economy.
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The Aggregate
Demand Curve
When a change in the price level causes equilibrium
GDP to change, we move along the AD curve.
Whenever anything other than the price level causes
equilibrium GDP to change, the AD curve itself
shifts.
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The Aggregate
Demand Curve
The AD curve shifts rightward when
government purchases, investment spending,
autonomous consumption spending, or net
exports increase, or when taxes decrease.
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The Aggregate
Demand Curve
The AD curve shifts leftward when
government purchases, investment spending,
autonomous consumption spending, or net
exports decrease, or when taxes increase.
© 2001 South-Western, a division of Thomson Learning
The Aggregate
Demand Curve
An increase in the money supply shifts the AD
curve rightward. A decrease in the money
supply shifts the AD curve leftward.
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The Aggregate Supply Curve
•Prices and Costs in the Short Run
•Deriving the Aggregate Supply Curve
•Movements Along the AS Curve
•Shifts of the AS Curve
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The Aggregate Supply Curve
A firm sets the price of its products as a
markup over cost per unit.
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The Aggregate Supply Curve
The average percentage markup in the economy is
determined by competitive conditions in the economy. The
competitive structure of the economy changes very slowly,
so the average percentage markup should be somewhat
stable from year to year.
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The Aggregate Supply Curve
In the short run, the price level rises when
there is an economy-wide increase in unit
costs, and the price level falls when there is an
economy-wide decrease in unit costs.
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The Aggregate Supply Curve
As total output increases …
•Greater amounts of inputs may be needed to produce a
unit of output.
•The prices of non-labor inputs rise.
•The nominal wage rate rises.
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The Aggregate Supply Curve
For a year or so after a change in output,
changes in the average nominal wage are less
important than other forces that change unit
costs.
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The Aggregate Supply Curve
Assume that changes in output have no effect
on the nominal wage rate in the short run.
© 2001 South-Western, a division of Thomson Learning
The Aggregate Supply Curve
In the short run, a rise in real GDP, by causing unit
costs to increase, will also cause a rise in the price
level. A fall in real GDP, by causing unit costs to
decrease, will also cause a decrease in the price
level.
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The Aggregate Supply Curve
Aggregate Supply (AS) Curve
A curve indicating the price level consistent
with firms’ unit costs and markups for any
level of output over the short run.
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The Aggregate Supply Curve
When a change in real GDP causes the price level to
change, we move along the AS curve. When
anything other than a change in real GDP causes
the price level to change, the AS curve itself shifts.
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The Aggregate Supply Curve
Examples of Changes That Shift AS
•Changes in world oil prices
•Changes in the weather
•Technological change
•Adjustment to the long run
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AD and AS Together:
Short-Run Equilibrium
Short-Run Macroeconomic Equilibrium
A combination of price level and GDP
consistent with both the AD and AS curves.
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What Happens
When Things Change?
•Demand Shocks in the Short Run
•Demand Shocks: Adjusting to the Long Run
•The Long-Run Aggregate Supply Curve
•Supply Shocks
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What Happens
When Things Change?
Demand Shock
Any event that causes the AD curve to shift.
Supply Shock
Any event that causes the AS curve to shift.
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What Happens
When Things Change?
When government purchases increase, the horizontal shift
of the AD curve measures how much real GDP would
increase if the price level remained constant. But because
the price level does rise, real GDP rises by less than the
horizontal shift in the AD curve.
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What Happens
When Things Change?
A positive demand shock--one that shifts the AD curve
rightward--increases both real GDP and the price level in
the short run. A negative demand shock--one that shifts the
AD curve leftward--decreases both real GDP and the price
level in the short run.
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What Happens
When Things Change?
In the short run, we treat the wage rate as given. But in the
long run, the wage rate can change. When output is above
full employment, the wage rate will rise, shifting the AS
curve upward. When output is below full employment, the
wage rate will fall, shifting the AS curve downward.
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What Happens
When Things Change?
Self-Correcting Mechanism
The adjustment process through which price
and wage changes return the economy to fullemployment output in the long run.
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What Happens
When Things Change?
When output exceeds its full-employment level, wages will
eventually rise, causing a rise in the price level and a drop
in GDP until full employment is restored. When output is
less than its full-employment level, wages will eventually
fall, causing a drop in the price level and a rise in GDP
until full employment is restored.
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What Happens
When Things Change?
Long-Run Aggregate Supply Curve
A vertical line indicating all possible output
and price-level combinations at which the
economy could end up in the long run.
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What Happens
When Things Change?
The self-correcting mechanism shows us that,
in the long run, the economy will eventually
behave as the classical model predicts.
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What Happens
When Things Change?
In the short run, a negative supply shock
shifts the AS curve upward, decreasing
output and increasing the price level.
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What Happens
When Things Change?
Stagflation
The combination of falling output and rising
prices.
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What Happens
When Things Change?
A negative supply shock causes stagflation in
the short run.
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What Happens
When Things Change?
A positive supply shock shifts the AS curve
downward, increasing output and decreasing
the price level.
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What Happens
When Things Change?
In the long run, the economy self-corrects after a
supply shock, just as it does after a demand shock.
When output differs from its full-employment level,
the wage rate changes, and the AS curve shifts until
full employment is restored.
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Some Important Provisos
About the AS Curve
•Some prices take time to adjust.
•In some industries, wages respond quickly.
•There is more to the process of recovering from a
shock than the adjustment of prices and wages.
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