Unit 4.3 Aggregate demand and supply

• Aggregate demand (AD)


  Measurement of the total amount of demand for all finished goods and services produced in an economy

  
• Law of demand


  • Demand level for a product or resource will decline as its price rises, and rise as the price drops

  
• Sources of aggregate demand

  • Households
  • Firms
  • Government
  • Foreign sector
• Aggregate demand curve


  Shows an inverse relationship between aggregate demand and the general price level

  
• Fall in general price level

  Causes an expansion of AD
• Rise in general price level

  Causes a contraction of AD
• Determinants of aggregate demand

  • Consumer expenditure
  • Investment
  • Government spending
  • Net exports

  
• Aggregate demand curve


  • Shows the different qualities of total demand for the economy's products
  • Similar to the demand curve, but when the price is falling it relates to the price of most products are changing in the same direction

  
• Price level rises


  • Causes the wealth effect (inverse relationship between price level and real value of consumption spending)
  • Causes the international effect (tendency for change in price level to affect net exports)
  • Causes the interest rate effect (rise in price level will increase demand for money to pay higher prices, increasing interest rates)

  
• Shift in aggregate demand curve

  • Caused by factors independent of changes in the general price level
  • Outward shift means higher level of demand at each price level
  • Inward shift means total expenditure on goods and services at each price level has fallen

  
• Aggregate supply (AS)


  1. The total planned supply of all the producers in the economy

  2. The total quantity of output firms will produce and sell (the real GDP)
• Potential GDP


  The maximum quantity that an economy can produce given full employment of its existing levels of labour, physical capital, technology, and institutions
• Short-run aggregate supply (SRAS)


  • Represents the positive relationship between the aggregate price level and amount of aggregate output supplied in an economy
  • The short run is the period when some production costs and output prices are fixed

  
• Long-run aggregate supply (LRAS)

  • Shows the relationship between price level and real GDP that would be supplied if all prices, including nominal wages, were fully flexible
  • The long run is the period when all production costs, as well as output prices, are flexible

  
• Short-Run Aggregate supply (SRAS)

  • Slopes up from left to right (positive relationship)
  • As price rises, suppliers are willing and able to sell more goods and services due to the profit effect, cost effect, and misinterpretation effect

  
• Factors that shift the SRAS curve

  • Change in price of the factors of production
  • Change in tax on firms
  • Change in labour productivity / quality
  • Change in the quantity of resources (Can be due to supply-side shocks)

  
• Long-run aggregate supply curve

  • Keynesians represent it as perfectly elastic at low rates of output, then upward sloping over a range output and finally perfectly inelastic
  • New Classical economists represent it as a vertical line because they think the economy will operate at full capacity in the long run

  
• Causes of a shift in the LRAS curve

  • Net immigration
  • Increase in retirement age
  • More women labourers
  • Net investment
  • Discovery of new resources
  • Land reclamation
  • Improved education and training
  • Advances in technology