Chapter 12 Aggregate Demand and Aggregate Supply1.The aggregate demand-aggregate supply model(AD-AS model) is a flexible –price model that enables analysis of simultaneous changes of real GDP and the price level.2. The aggregate demand curve shows the level of real output that the economy demands at each price level. 3. The aggregate demand curve is downsloping because of the real-balances effect , the interest-rate effect, and the foreign purchases effect. The-real-balances effect indicates that inflation reduces the realvalue or purchasing power of fixed-value financial assets held by households, causing cutbacks in consumer spending. The interest-rate effect means that, with a specific supply of money, a higher price level increases the demand for money, thereby rasising the interest rate and reducing investment purchases. The foreign purchases effect suggests that an increase in one country’s price level relative to the price levels in other countries reduces the net export component of that nation’s aggregate demand.4. The determinants of aggregate demand consist of spending by domestic consumers, by businesses, by government, and by foreign buyers. Changes in the factors listed in Figure 12.2 alter the spending by these groups and shift the aggregate demand curve. The extent of the shift is determined by the size of the initial change in spending and the strength of the economy’s multiplier.5. The aggregate supply curve shows the levels of real output that businesses will produce at various possible price levels. The slope of the aggregate supply curve depends upon the flexibility of input and output prices. Since these vary over time, aggregate supply curves are categorized into three time horizons, each having different underlying assumptions about the flexibility of input and output prices. 6. The immediate-short-run aggregate supply curve assumes that both input prices and output prices arefixed. With output prices fixed, the aggregate supply curve is a horizontal line at the current price level. The short-run aggregate supply curve assumes nominal wages and other input prices remain fixed while output prices vary. The aggregate supply curve is generally upsloping because per-unit production costs, and hence the prices that firms must receive, rise as real output expands. The aggregate supply curve is relatively steep to the right of the full-employment output level and relatively flat to the left of it. The long-run aggregate supply curve assumes that nominal wages and other input prices fully match any change in the price level. The curve is vertical at the full-employment output level.