Lu10: Aggregate Demand and Aggregate Supply (The AD curve (Why AD downward…
Lu10: Aggregate Demand and Aggregate Supply
3 key facts about economic fluctuation
Most macroeconomic variables fluctuate together
measure some type of income or production fluctuate closely together.
fluctuate by different amounts.
As output falls, unemployment rises
Changes in real GDP are inversely related to changes in the unemployment rate
During times of recession, unemployment rises substantially
irregular and unpredictable
called the business cycle.
not follow regular or easily predictable patterns.
Short Run economic fluctuations
The Assumptions of Classical Economics
Most economists believe that classical theory describes the world in the long run but not in the short run.
If the quantity of money in the economy were to double, prices would double and so would incomes. Real variables would remain constant.
Changes in the money supply affect nominal variables but not real variables in the long run.
The AD curve
shows the quantity of goods and services that households, firms, and the government want to buy at each price level.
The four components of GDP (Y) Y = C + I + G + NX
Why AD downward sloping
The Price Level and Consumption:
The Wealth Effect
The Price Level and Investment:
The Interest Rate Effect
The Price Level and Net Exports:
The Exchange-Rate Effect
Why AD Curve Might Shift
Shifts might arise from changes in:
The AS curve
shows the quantity of goods and services that firms choose to produce and sell at each price level.
vertical because the price level does not affect long run determinants of real GDP.
In SR, AS curve is upward sloping
LR AS curve is vertical at the
Shifts might arise from changes in
Causes of economic fluctuations
Shifts in Aggregate Supply
Consider an adverse shift in aggregate supply:
A decrease in one of the determinants of aggregate supply shifts the curve to the left.
Output falls below the natural rate of employment.
The price level rises.
a period of recession and inflation.
Output falls and prices rise.
Policy Responses to Recession
Do nothing and wait for prices and wages to adjust
Take action to increase aggregate demand by using monetary and fiscal polic
Shifts in Aggregate Demand
SR, shifts AD cause fluctuations in the economy’s output of goods and services.
LR shifts in AD ffect the overall price level but do not affect output.
Policymakers influence AD can potentially mitigate the severity of economic fluctuations