AD - AS
Price Level
Aggregate Demand Curve
Aggregate
Demand
AD
Real Domestic Output, GDP
29-2
Aggregate Demand
 Amount of real GDP purchased at each price
level
 AD = C + I + G + Xn
 Why the downward slope?
 No income or substitution effect like regular demand
 Wealth (real balances) effect: purchasing power of
held assets (C)
 Interest-rate effect: demand for $ (I)
 Foreign purchases effect (X)
 Consumption, investment, and net exports
29-3
Shifters of Aggregate
Demand
GDP = C + I + G + Xn
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ACDC Leadership 2015
Changes in Aggregate Demand
Increase in
Aggregate
Demand
Price Level
**Notice
the
multiplier
effect
Decrease in
Aggregate
Demand
AD2
AD1
AD3
Real Domestic Output, GDP
29-5
Shifters of Aggregate Demand
1. Change in Consumer Spending
Increase in Disposable Income or Wealth
(Higher incomes/Value of assets)
Consumer Expectations (People fear a recession…)
Household Indebtedness (More consumer debt…)
Taxes (Decrease in income taxes…)
2. Change in Investment Spending
6
Real Interest Rates (r = i)
- Price of borrowing $ - related to money supply
(If interest rates increase…)
(If interest rates decrease…)
Future Business Expectations (High expectations…)
Productivity and Technology (New robots…)
Business Taxes (Higher corporate taxes means…)
Shifters of Aggregate Demand
3. Change in Government Spending
Government Expenditures - *non-transfers only
(Decrease in defense spending…)
(Increase in public works programs…)
4. Change in Net Exports (X-M)
Exchange Rates
(If the us dollar depreciates relative to the euro…)
National Income Compared to Abroad
(If a major importer has a recession…)
(If the US has a recession…)
AD = GDP = C + I + G + Xn
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7
Aggregate Supply - Stages
 Amount real GDP produced at each
price level
 Three time horizons:
1. Immediate short run
 Few days to a few months
 Sticky prices and wages
 All prices fixed (input and output)
 Implicit price agreements (output)
 Contractual agreements (input)
29-8
Price Level
Aggregate Supply –
Immediate Short Run
ASISR
Immediate-shortrun Aggregate
Supply
Qf
Real Domestic Output, GDP
29-9
Immediate Short Run
29-10
Aggregate Supply - Stages
2. Short run
Input prices fixed, Output prices
variable
In the Short Run, do firms prefer
increase or decrease in Price Level?
Increase! – Fixed input contracts
Real profit changes
29-11
Aggregate Supply – Short Run
Slope not constant: per unit production cost
and firm capacity
Price Level
Aggregate Supply
(Short Run)
0
Competition for
resources hikes
ATC
Plentiful resources limit
growth of ATC
Qf
Real Domestic Output, GDP
29-12
Aggregate Supply - Stages
3. Long run
All prices variable – inputs
and outputs
Full employment GDP
All prices adjust
Aggregate Supply – Long Run
Price Level
**In the long
run, the
economy will
produce at
the full
employment
output.
ASLR
Long-run
Aggregate
Supply
Qf
Real Domestic Output, GDP
29-14
Determinants of Aggregate Supply:
1. Change in input price (land, labor, capital)
 Domestic resource prices
 Prices of imported resources
 Supply shocks
2. Change in productivity/technology
3. Change in legal-institutional environment
 Business taxes and subsidies
 Government regulation
29-15
Determinants of Aggregate Supply
 RPG
 Resource Prices
 Productivity
 Government taxes, subsidies, regulation
***Government ACTION - not government spending
29-16
Aggregate Supply
AS3
AS1
AS2
Price Level
Decrease in
Aggregate
Supply
Increase in
Aggregate
Supply
Real Domestic Output, GDP
29-17
Practice
AD or AS
1
2
3
4
5
6
7
8
9
10
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ACDC Leadership 2015
Shifter
Increase or
Decrease
Practice
1. An increase in consumer spending
2. The impact on net exports when a trading partner
has a recession
3. A significant increase in the price of oil that affects
the resource costs of businesses
4. Government increases spending but not taxes
5. Increase in wages that businesses pay workers
6. Effect on businesses when they expect inflation
7. Effect on investment when interest rates decrease
8. An increase in productivity
9. The impact on next exports when the country’s
currency depreciates
10. Government increases corporate taxes
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Practice
AD or AS
Shifter
Increase or Decrease
1
2
AD
AD
C
X
Increase
Decrease
3
4
5
6
7
AS
AD
AS
AS
AD
R
G
R
R
I
Decrease
Increase
Decrease
Decrease
Increase
8
AS
P
Increase
9
10
AD
AS
X
A
Increase
Decrease
20
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ACDC Leadership 2015
Use the AD and AS model to show an
economy at full employment output
Price
Level
LRAS
SRAS
PLe
AD
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ACDC Leadership 2015
QF
RGDP
21
#1. Assume there is an increase in consumer
spending. What happens to PL and output in the
short-run?
LRAS
Price
Level
SRAS
PL and Q will
Increase
PL1
PLe
AD
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QF Q1
AD1
RGDP
22
Inflationary and
Recessionary Gaps
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23
The economy can only be in one of
three places at any time
Capital Goods
Max Capacity
0% Unemployment
Real
GDP
Real
GDP
Consumer Goods
Full Employment
5% Unemployment
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Time
Recessionary Gap
Full Employment
Inflationary Gap
24
Example: Assume the government increases
spending. What happens to PL and Output?
Price
Level
LRAS
SRAS
PL and Q will
Increase
PL1
PLe
AD
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QF Q1
AD1
RGDP
25
Inflationary Gap
Output is high and unemployment is less than NRU
LRAS
Price
Level
SRAS
Actual GDP
above potential
GDP
PL1
AD1
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QF Q1
RGDP
26
Example: Assume consumer spending falls.
What happens to PL and Output?
LRAS
Price
Level
SRAS
PL and Q will
decrease
PLe
PL1
AD1
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Q1
QF
AD
RGDP
27
Recessionary Gap
Output low and unemployment is more than NRU
LRAS
Price
Level
SRAS
Actual GDP
below potential
GDP
PL1
AD1
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Q1
QF
RGDP
28
Example: If there is a negative “supply shock”
of oil. What happens to PL and Output?
Price
Level
LRAS
SRAS1
SRAS
Stagflation
PL1
Stagnate Economy
+ Inflation
PLe
Still considered
recessionary gap
AD
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Q1 QF
RGDP
29
2008 Audit Exam
2008 Audit Exam
2008 Audit Exam
2012 Exam
AD and AS Practice
Worksheet
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35
What Happens In the
Long-Run?
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36
If consumer spending increases, what will
happen in the short-run and in the long-run?
In the long-run, wages and costs increase
LRAS
SRAS1
Real
GDP
Price
Level
SRAS
PL2
Real
GDP
PL1
PLe
AD AD1
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ACDC Leadership 2015
QF Q1
RGDP
Time
37
If consumer spending increases, what will
happen in the short-run and in the long-run?
In the long-run, wages and costs increase
LRAS
SRAS1
Real
GDP
Price
Level
PLe
Real
GDP
AD1
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ACDC Leadership 2015
QF
RGDP
Time
38
If consumer spending decreases, what will
happen in the short-run and in the long-run?
In the long-run, wages & costs eventually decrease
LRAS
SRAS
Real
GDP
Price
Level
SRAS2
PLe
PL1
Real
GDP
PL2
AD2 AD
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Q1 QF
RGDP
Time
39
Practice
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40
#1. Assume there is an increase in government
spending. What happens to PL and output in the
short- run?
LRAS
Price
Level
SRAS
PL and Q will
Increase
PL1
PLe
AD
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ACDC Leadership 2015
QF Q1
AD1
RGDP
41
#2. Consumer expectations fall and consumer
spending plummets. What happens to price level
and output in the long-run?
Price
Level
LRAS
SRAS
SRAS1
Price Level
decreases and
output stay s the
AD same
PLe
PL1
PL2
AD1
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Q1 QF
RGDP
42
#3. If consumer spending increases, what happens
to price level and output in the long-run?
Price
Level
LRAS
PL2
SRAS1
SRAS
Price level
increases and
output stays the
same
PL1
PLe
AD
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QF Q1
AD1
RGDP
43
2008 Audit Exam
Economic Growth
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45
If investment increases, what happens in the
short-run and long-run?
Capital Stock- Machinery and tools purchased by
businesses that increase their output
LRAS LRAS1
AS AS1
PL1
PLe
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QF
AD1
AD
Q1 QF1 GDPR
Capital Goods
Price
Level
The PPC shifts outward since
producers can make more
Consumer Goods
46
Productivity Increases
An increase in consumption or government
spending doesn’t cause economic growth.
Only Investment causes growth since firms
increase their capital stock
LRAS1
AS1
Capital Goods
Price
Level
PLe
AD1
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ACDC Leadership 2015
QF1
GDPR
Consumer Goods
48
2008 Audit Exam
2008 Audit Exam
2012 FRQ #3
51
2012 FRQ #3
52