Economist use the model of aggregate demand and aggregate supply to explain short-run fluctuationsThe aggregate demand curve shows the quantity of goods and services that households, firms, and the government want to buy at each price level.The aggregate supply curve shows the quantity of goods and services that firms produce and sell at each price level.
4 steps for analyzing macroeconomic Fluctuations
1. Decide whether the event shift aggregate demand or supply curve
2. Decide in which direction the curve shifts
3. Use diagram to see how shift changes output & price level
4. Use diagram to see how economy moves from short run equilibrium to long run equilibrium
Aggregate Demand and Aggregate Supply...
The Aggregate-Demand Curve...
2. …increases the quantity of goods and services demanded.
1. A decrease in the price level...
aggregate demand for goods and services.
Y = C + I + G + NX
Why the Aggregate Demand Curve Is Downward Sloping
The Price Level and Consumption: The Wealth Effect
The Price Level and Investment: The Interest Rate Effect
The Price Level and Net Exports: The Exchange-Rate Effect
Cont…. WEALTH EFFECT : decrease in the price level
makes consumers feel more wealthy, which in turn encourages them to spend more.
INTEREST RATE EFFECT : A lower price level reduces the interest rate, which encourages greater spending on investment goods.
EXCHANGE RATE EFFECT : When a fall in the Indian price level causes Indian interest rates to fall, the real exchange rate depreciates, which stimulates India net exports.
Why Aggregate demand curve shift
shift arises because of
C , I , G , NX
The Long-Run Aggregate Supply Curve
In the long run, the aggregate-supply curve is vertical.
The long-run aggregate supply curve is vertical at the natural rate of output.
This level of production is also referred to as potential output or full-employment output.
The Long-Run Aggregate- Supply Curve...
Natural rateof output
P2 2. …does not affect the quantity of goods and services supplied in the long run.
1. A change in the price level…
Why the Long-Run Aggregate Supply Curve Might Shift
Shifts arising from Labor Shifts arising from Capital Shifts arising from Natural
Resources Shifts arising from Technological
1. In the long-run, technological progress shifts long-run aggregate supply...
Long-Run Growth and Inflation...
2. …and growth in the money supply shifts aggregate-demand...
4. …and ongoing inflation.
3. …leading to growth in output...
The Short-Run Aggregate Supply Curve...
2. reduces the quantity of goods and services supplied in the short run.
1. A decrease in the price level
Why the Short-Run Aggregate Supply Curve Slopes Upward in
the Short Run
The Sticky-Wage Theory The Sticky-Price Theory The Misperceptions Theory
Why the Short run Aggregate Supply Curve Might Shift
Shifts arising from Labor, Capital, Natural Resources, Technology.
Shifts arising from the Expected Price Level.An increase in the expected price level reduces the quantity of goods and services supplied because higher wages to be paid, high cost so less production
A decrease in the expected price level raises the quantity of goods and services supplied because lower wage, low cost so more production.
Effect of shift in Aggregate Demand
In the short run, shifts in aggregate demand cause fluctuations in the economy’s output of goods and services.
In the long run, shifts in aggregate demand affect the overall price level but do not affect output.
1. A decrease inaggregate demand…
A Contraction in Aggregate Demand...
Short-run aggregatesupply, AS1
2. …causes output to fall in the short run…
3. …but over time,the short-run aggregate-supply curve shifts…
4. …and output returnsto its natural rate.
Effect of shift in Aggregate Supply
A decrease in one of the determinants of aggregate supply shifts the curve to the left: Output falls below the natural rate of
employment. – (stagnation) Unemployment rises. The price level rises. – (inflation) Adverse shifts in aggregate supply cause
stagflation—a combination of recession and inflation.
1. An adverse shift in the short-run aggregate-supply curve…
supplyShort-run aggregatesupply, AS1
An Adverse Shift in Aggregate Supply...
3. …and the price level to rise.
2. …causes output to fall…
Policy Responses to Recession
Policymakers may respond to a recession in one of the following ways: Do nothing and wait for prices and wages to
adjust. Take action to increase aggregate demand by
using monetary and fiscal policy.
1. When short-run aggregate supply falls…
Accommodating an Adverse Shift in Aggregate Supply...
Natural rateof output
Short-run aggregate supply, AS1
Aggregate demand, AD1
3....which causes the price level to rise
4. …but keeps output at its natural rate.
C 2. …policymakers canaccommodate the shiftby expanding aggregatedemand…AD2