7: Chapter Aggregate Demand and Aggregate Supply Aggregate Demand = the quantity demanded of all goods and services (Real GDP) at different price levels, ceteris paribus. Aggregate Demand curve = graphical representation of aggregate demand Slopes downward
Real balance effect = the inverse relationship between the price level and the quantity demanded of Real GDP is established through changes in the value of monetary wealth (money holdings) Purchasing power = the quantity of goods and services that can be purchased with a unit of money
Interest Rate Effect = the inverse relationship between the price-level and the quantity demanded of Real GDP is established through changes in household and business spending that is sensitive to changes in interest rates International Trade Effect = the inverse relationship between the price level and quantity demanded of Real GDP is established through foreign sector spending A change in the quantity demanded of Real GDP moves down/up the line of the graph A change in aggregate demand shifts the curve A rise in consumption, investment, government purchases, or net exports will raise spending on US goods and services If, at a given price level, consumption, gvt. Purchases, investment, or net exports rise, aggregate demand will rise and the AD curve will shift to the right If, at a given price level, consumption, gvt purchases, investment or net exports fall, aggregate demand will fall and the AD curve will shift to the left Factors that can change C, I, G, and NX Consumption: Investment Interest Rate Expectations about future sales Wealth Expectations about future prices and income Interest rate Income taxes
Net Exports -
Business taxes
Foreign real national income Exchange rate = price of one currency in terms of another currency o Appreciation = an increase in value of one currency relative to other currencies o Depreciation = a decrease in the value of one currency relative to other currencies foreign Makes goods more expensive
Aggregate Supply = the quantity supplied of all goods and services (Real GDP) at different price levels Short-run aggregate supply curve = a curve that shows the aggregate supply at different price levels Short run because the determining factors are likely to change in the future Slopes upward o Sticky wages Due to security reasons, wages are set in advance sometimes for several years Real wage = nominal wage/price level Quantity supplied of labor is directly related to the real wage Quantity demanded of labor is inversely related to the real wage o Worker misperceptions With falling real wage, workers may reduce the quantity of labor they are willing to supply Can be shifted by: o wage rates Rise in equilibrium wage rates shifts curve to the left Fall in equilibrium wages shifts curve left o Prices of nonlabor inputs Changes in prices (i.e. oil) shift the curve o Productivity = the output produced per unit of input employed over some period of time Increase in labor = increase in output = curve shifts right Decrease in labor = decrease in output = curve shifts left o Supply shocks= major natural or institutional changes on the supply side of the economy that affect aggregate supply Adverse supply shocks shifts left Beneficial supply shocks shifts right
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Short Run Equilibrium = the condition that exists in the economy when the quantity demanded of Real GDP equals the short run quiantity supplied of Real GDP; where the two lines intersect on a graph Long Run Aggregate Supply
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In time, wages become unstuck and misperceptions become more accurate Natural Real GDP = the real GDP that is produce at the natural unemployment rate; the real GDP that is produced when the economy is in long-run equilibrium Long run equilibrium = the condition that exists in the economy when wages and prices have adjusted to their final equilibrium levels and workers do not have any relevant misconceptions