Aggregate Demand and Aggregate Supply and Curves

Informative slides for students :)

1. GROUP MEMBERS MUHAMMAD SHAHROZE ILYAS MUBEEN ABDUL SHAKOOR ADEEL ASIF MUHAMMAD FAHAD KHAN

2. AGGREGATE-DEMAND In economics aggregate demand is the total demand for final goods and services in the economy at a given time and price level. Aggregate demand is the gross domestic product of a country when inventory levels are static

3. Aggregate Demand The sum of all expenditure in the economy over a period of time Macro concept – WHOLE economy Formula: AD = C+I+G+(X-M) C = Consumption Spending I = Investment Spending G = Government Spending (X-M) = difference between spending on imports and receipts from exports (Balance of Payments)

4. Aggregate Demand –Key Variables Consumption Expenditure Investment Expenditure Government Expenditure Import Spending Export Earning

5. Consumption Expenditure Exogenous factors affecting consumption: Tax rates Incomes – short term and expected income over lifetime Wage increases Credit Interest rates Wealth Property Shares Savings Bonds

6. Investment Expenditure Spending on: Machinery Equipment Buildings Infrastructure Influenced by: Expected rates of return Interest rates Expectations of future sales Expectations of future inflation rates

7. Government Spending Defence Health Social Welfare Education Foreign Aid Regions Industry Law and Order

8. Import Spending (negative) Goods and services bought from abroad – represents an outflow of funds from the country (reduces AD)

9. Export Earnings (Positive) Goods and services sold abroad – represents a flow of funds into the country (raises AD)

10. Aggregate Demand Curve The aggregate demand (AD) curve is a curve that shows the negative relationship between aggregate output (income) and the price level

11. Deriving the Aggregate Demand Curve To derive the aggregate demand curve, we examine what happens to aggregate output (income) ( Y ) when the price level ( P ) changes, assuming no changes in government spending ( G ), net taxes ( T ), or the monetary policy variable ( M s ).

12. Deriving the Aggregate Demand Curve The AD curve is not a market demand curve, and it is not the sum of all market demand curves in the economy. It is a more complex concept .

13. Aggregate Demand Curve Aggregate demand falls when the price level increases because the higher price level causes the demand for money to rise, which causes the interest rate to rise. It is the higher interest rate that causes aggregate output to fall. At all points along the AD curve, both the goods market and the money market are in equilibrium.

14. Reasons why AD is downward sloping The consumption link: The decrease in consumption brought about by an increase in the interest rate contributes to the overall decrease in output. The real wealth effect , or real balance , effect : When the price level rises, there is a decrease in consumption brought about by a change in real wealth.

15. Shifts in AD Changes in Governmental Policies Changes in Monetary Policy Changes in Expectations of Households and Firms

16. Factors that Effect Aggregate Demand 1. Income 2. Wealth 3. Population 4. Interest rates 5. Credit availability 6. Government demand 7. Taxation 8. Foreign demand 9. Investment 10. Expectations (a) Inflationary (b) Income (c) Wealth (d) Interest rate (+) (+) (+) (–) (+) (+) (–) (+) (+) (+) (+) (+) (+)

17. AGGREGATE SUPPLY

18. AGGREGATE SUPPLY A ggregate supply is the total supply of goods and services in an economy.

19. AGGREGATE SUPPLY CURVE Curve shows relation between aggregate quantity of output supplied by all the firms in an economy and overall price level. It is not a market supply curve ,and it is not simple sum of all individual supply curves. Rather than an aggregate supply curve, what does exist is a “price/output response” curve

20. AGGREGATE SUPPLY IN THE SHORT RUN In the short run, the aggregate supply curve (the price/output response curve) has a positive slope

21. AGGREGATE SUPPLY IN THE SHORT RUN Macroeconomists focus on whether or not the economy as a whole is operating at full capacity. As the economy approaches maximum capacity, firms respond to further increases in demand only by raising prices.

22. AGGREGATE SUPPLY IN THE SHORT RUN At low levels of aggregate output the curve is fairly flat. As economy approaches capacity, the curve becomes nearly vertical. At capacity, the curve is vertical.

23. The Response of Input Prices to Changes in the Overall Price Level There must be a lag between changes in input prices and changes in output prices, otherwise the aggregate supply (price/output response) curve would be vertical. Wage rates may increase at exactly the same rate as the overall price level if the price-level increase is fully anticipated. Most input prices, however, tend to lag increases in output prices.

24. WHY IS THE SHORT RUN CURVE UPWARD SLOPING? Short-run aggregate supply curve slopes upward because: Contracts make some wages and prices “sticky.” Firms are often slow to adjust wages. Menu costs make some prices sticky

25. Shifts of the Short-Run Aggregate Supply Curve A decrease in aggregate supply An increase in aggregate supply

26. Bad weather, natural disasters, destruction from wars Good weather Public policy waste and inefficiency over-regulation Public policy supply-side policies tax cuts deregulation Stagnation capital deterioration Economic growth more capital more labor technological change Higher costs higher input prices higher wage rates Lower costs lower input prices lower wage rates Shifts to the Left Decreases in Aggregate Supply Shifts to the Right Increases in Aggregate Supply Factors That Shift the Aggregate Supply Curve Shifts of the Short-Run Aggregate Supply Curve

27. The Equilibrium Price Level AD represents money and goods market in equilibrium. AS represents price/output decisions of all firms in ecomony . P and Y correspond to equilibrium in the goods market and the money market and a set of price/output decisions on the part of all the firms in the economy.

28. The Long-Run Aggregate Supply Curve Costs lag behind price-level changes in the short run, resulting in an upward-sloping AS curve. Costs and the price level move in tandem in the long run, and the AS curve is vertical.

29. The Long-Run Aggregate Supply Curve Output can be pushed above potential GDP by higher aggregate demand. The aggregate price level also rises.

30. The Long-Run Aggregate Supply Curve When output is pushed above potential, there is upward pressure on costs, and this causes the short-run AS curve to the left. Costs ultimately increase by the same percentage as the price level, and the quantity supplied ends up back at Y .

31. The Long-Run Aggregate Supply Curve Y represents the level of output that can be sustained in the long run without inflation. It is also called potential output or potential GDP .

32. THANK YOU