The document summarizes the aggregate supply (AS) and aggregate demand (AD) model. It defines AS and AD as relationships between price levels and real GDP. The intersection of the AS and AD curves determines equilibrium output and price levels. The document outlines the components of aggregate demand as consumption, investment, government spending, and net exports. It also discusses factors that can cause shifts in the AS and AD curves, such as income, wealth, interest rates, and exchange rates.

2. PREPARED BY
UMAIR

3. The AS/AD model is the basic macroeconomic tool for
studying output fluctuations and the determination of
the price level and the inflation rate
◦ Can be used to explain how the economy deviates from a path
of smooth growth over time, and to explore the consequences
of government policies intended to reduce unemployment and
output fluctuations, and maintain stable prices

4.  Aggregate demand – a relationship between the price
level and the equilibrium quantity of real GDP
demanded.
 Aggregate supply – a relationship between the price
level and the equilibrium quantity of real GDP
supplied.
 Intersection of AS and AD curves determines the
equilibrium level of output and price level

5. AS and AD intersect at point
E in Figure
 Equilibrium: AS = AD
Equilibrium output is Y0
Observed level of output in
the economy at particular
point in time
Equilibrium price level is P0
Observed price level in the
economy at particular
point in time

6. The amount of the increase/decrease
in P and Y after a shift in either
aggregate supply or aggregate
demand depends on:
1. The slope of the AS curve
2. The slope of the AD curve
3. The extent of the shift of AS/AD

7.  Aggregate demand (AD) consists of spending on
GDP by:
◦ consumers (C)
◦ firms (I)
◦ the government (G), and
◦ the foreign sector (NX)
 Anything that increases C, I, G, or NX at a given
price level results in an increase in AD.

8.  Income
 Wealth
 Expected future income and wealth
 Demographics
 Taxes

9.  Interest rate
 Technology
 Cost of capital goods
 Capacity utilization

10. Determined by government authorities

11.  Foreign and domestic income
 Foreign and domestic price levels
 Exchange rates
 Government policy (tariffs, trade restrictions, etc.)

12.  AE = C+I+G+NX
 AE is affected by any factor that changes C, I, G, or
NX.

13.  Note that AD curve is not the same as the demand
curve for a particular good
◦ negative slope is NOT the result of income and substitution
effects
 Why is it downward sloping?
◦ Wealth effect
◦ Interest rate
◦ International trade effect

14.  As the price level rises:
◦ the real value of dollar-denominated assets decline (real wealth
declines)
◦ this decline in wealth results in a reduction in consumption
spending
 This affect is also called the real-balance effect (or
Pigou effect)

15.  As the price level rises:
◦ Individuals must hold more money to pay for transactions
◦ To acquire more money, households sell bonds, and other
financial assets.
◦ As more bonds are sold, the price of bonds declines
◦ A decline in bond prices results in a higher rate of return
(interest rate) on bonds and other financial assets
◦ A higher interest rate results in a reduction in investment and
consumption spending

16.  As the domestic price level rises:
◦ Imports become relatively cheaper,
◦ Exports become relatively more expensive
◦ Exports decline, imports rise, and net exports decline

17. As the price level rises, AE falls due to the combined
wealth, interest-rate, and international trade effects

18.  Anything that changes C, I, G, or NX at a given price
level will cause the AD curve to shift
 Effects of:
◦ Expectations (consumer and investor confidence)
◦ Foreign income and price levels
◦ Government policy

19.  Price-level effects
◦ Assumption: Resource prices adjust more slowly than output
prices
◦ As price level rises, production becomes more profitable and
the quantity of output supplied rises.

22. Resource and output prices are assumed to be
flexible in the long run. Output = potential real
GDP.

23.  Resource prices
 Technology
 Expectations

24.  Changes in the quantity and/or quality of resources
 Technology