REV - Aggregate Supply and Aggregate Demand

APMAC_Lesson_TopBanner.png

Aggregate Supply and Aggregate Demand

 

Aggregate Demand

In macroeconomics, aggregate demand (AD) or domestic final demand (DFD) is the total demand for final goods and services in an economy at a given time. It specifies the amounts of goods and services that will be purchased at all possible price levels. This is the demand for the gross domestic product of a country.

Aggregate Demand Shifters

These cause shifts in aggregate demand:

1. C (consumer wealth, consumer expectations, household indebtedness, taxes)

2. I (interest rates, expected returns on investment, business taxes, technology, degree of excess capacity)

3. G

4. X n (National income abroad, exchange rates)

 

Spending Multipliers

The multiplier effect refers to the idea that an initial spending rise can lead to even greater increase in national income. In other words, an initial change in aggregate demand can cause a further change in aggregate output for the economy.

Since banks lend their excess reserves, a system of banks will “magnify” original excess reserves into a larger amount of new demand-deposit money, causing the money supply to grow by more than the original excess reserves.

The maximum demand-deposit creation (money created) equals the excess reserves that can be lent out by commercial banks times the money multiplier.

For example, if someone deposited $100 into a bank, and the required reserve ratio was 0.2, then the bank’s excess reserves would increase by $80, and since the money multiplier is 1/0.2=5, the money supply will be increased by 80*5=400.

 

Aggregate Supply

In economics, aggregate supply (AS) or domestic final supply (DFS) is the total supply of goods and services that firms in a national economy plan on selling during a specific time period. It is the total amount of goods and services that firms are willing and able to sell at a given price level in an economy.

Aggregate Supply Shifters

These cause shifts in aggregate supply:

1. Input Prices (domestic resource availability [land, labor, capital, entrepreneurial ability], prices of imported resources, market power)

2. Productivity

3. Legal – institutional environment (business taxes and subsides, government regulation)

 

Short Run Equilibrium

In the short run, the equilibrium price level and the equilibrium level of total output are determined by the intersection of the aggregate demand and the short-run aggregate supply curves. In the short run, output can be either below or above potential output.

 

LRAS and PPC

  • PPC = similar to LRAS (both represent most that can be produced with current factors of production)
  • LRAS = capabilities of production in economy (only looks at capital equipment, ideas, labor quality and quantity, and resources)
  • LRAS and LR Phillips Curve behave the same way as the Short run AS and Phillips Curve

 

Aggregate Supply LR

  • Recall that the definition of the long run is a period of time long enough for firms to change any of their inputs.
  • That is, all costs are variable, and there are no fixed costs.
  • The LRAS is vertical at the full employment, or potential level of real GDP
  • Full employment output is the level of real GDP that exists when the economy’s unemployment rate is at its natural rate.
  • This natural rate of unemployment doesn’t correspond to an unemployment rate of zero.
  • Rather, it is the unemployment rate that exists when there is no cyclical unemployment.

MEP_LRAS.png 

 

Watch the videos below for further review.

 

  

Review

After you have reviewed the material - try the challenge below:

 

APMAC_LessonBottomBanner.png IMAGES CREATED BY GAVS