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Aggregate Demand and Aggregate supply (The Basic Model of Economic…
Aggregate Demand and Aggregate supply
A recession
: a period of declining real incomes and rising unemployment, technically two successive quarters of declining real GDP. A
depression
is a severe recession
Key facts about economic fluctuation
:
Economic fluctuations are irregular and unpredictable.
Most macroeconomic variables fluctuate together.
As output falls, unemployment rises.
The Basic Model of Economic Fluctuation:
Two variables are used to develop a model to analyse the short-run fluctuations.
The economy’s output of goods and services measured by real GDP.
The overall price level measured by the CPI or the GDP deflator.
Economist use the model of aggregate demand and aggregate supply to explain
short-run fluctuations
in
economic activity
around its
long-run trend
.
The
aggregate-demand curve
shows the quantity of goods and services that households, firms, and the government want to buy at each price level
The
aggregate-supply curve
shows the quantity of goods and services that firms choose to produce and sell at each price level.
The four components of GDP (Y) contribute to the aggregate demand for goods and services.
Y = C + I + G + NX
Why the Aggregate Demand Curve Is Downward Sloping
.
The Price Level and Consumption: The Wealth Effect
A decrease in the price level makes consumers wealthier, which in turn encourages them to spend more.
This increase in consumer spending means larger quantities of goods and services demanded
The Price Level and Investment: The Interest Rate Effect
A lower price level reduces the interest rate, which encourages greater spending on investment goods.
This increase in investment spending means a larger quantity of goods and services demanded
The Price Level and Net Exports: The Exchange Rate Effect
When a fall in the Euro area price level causes Euro area interest rates to fall, the real exchange rate depreciates, which stimulates Euro area net exports.
The increase in net export spending means a larger quantity of goods and services demanded.
Why the Aggregate Demand Curve Might Shift
.
The downward slope of the aggregate demand curve shows that a fall in the price level raises the overall quantity of goods and services demanded.
Many other factors, however, affect the quantity of goods and services demanded at any given price level.
When one of these other factors changes, the aggregate demand curve shifts.
Consumption
Investment
Government Purchases
Net Exports
THE AGGREGATE SUPPLY CURVE
In the
long run
, the aggregate supply curve is
vertical.
In the
short run
, the aggregate supply curve is
upward sloping.
.
The Long-Run Aggregate Supply Curve
In the long run, an economy’s production of goods and services depends on its supplies of labour, capital, and natural resources and on the available technology used to turn these factors of production into goods and services.
The price level does not affect these variables in the long run.
The long-run aggregate supply curve is vertical at the natural rate of output.
This level of production is also referred to as potential output or full-employment output.
why it might shift in the long run
Labour
Capital
Natural Resources
Technological Knowledge