Chapter 10

Chapter 10 - Aggregate Demand and Aggregate Supply CHAPTER...

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CHAPTER TEN LECTURE NOTES I. Introduction to AD-AS Model A. Learning objectives – In this chapter students will learn: 1. About aggregate demand (AD) and the factors that cause it to change. 2. About aggregate supply (AS) and the factors that cause it to change. 3. How AD and AS determine an economy’s equilibrium price level and level of real GDP. 4. How the AD-AS model explains periods of demand-pull inflation, cost-push inflation, and recession. B. AD-AS model provides insights on inflation, unemployment and economic growth. II. Aggregate demand is a schedule or curve that shows the various amounts of real domestic output that domestic and foreign buyers will want to purchase at each possible price level. A. The aggregate demand curve is shown in Figure 10.1. 1. It shows an inverse relationship between price level and real domestic output. 2. The explanation of the inverse relationship is not the same as for demand for a single product, which centered on substitution and income effects. a. Substitution effect doesn’t apply within the scope of domestically produced goods, since there is no substitute for “everything.” b. Income effect also doesn’t apply in the aggregate case, since income now varies with aggregate output. 3. What is the explanation of the inverse relationship between price level and real output in aggregate demand? a. Real balances effect: When price level falls, the purchasing power of existing financial balances rises, which can increase spending. b. Interest-rate effect: A decline in price level means lower interest rates that can increase levels of certain types of spending. c. Foreign purchases effect: When price level falls, other things being equal, U.S. prices will fall relative to foreign prices, which will tend to increase spending on U.S. exports and also decrease import spending in favor of U.S. products that compete with imports. (Similar to the substitution effect.) B. Determinants of aggregate demand: Determinants are the “other things” (besides price level) that can cause a shift or change in demand (see Figure 10.2 in text).
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Chapter 10 - Aggregate Demand and Aggregate Supply CHAPTER...

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