Macroeconomics ECON202
Guided notes
Chapter 13 The Aggregate Demand–Aggregate Supply Model
Big Questions to study
A. What is the aggregate demand–aggregate supply model?
• The aggregate demand-aggregate supply model is a model that economists use to study business
cycles (short-run fluctuations in the economy)
B. What is aggregate demand?
• Aggregate demand represents the spending side of the economy. It is the total demand for final
goods and services in an economy. It includes consumption, investment, government spending,
and net exports
• The slope of the aggregate demand curve is negative due to the wealth effect, the interest rate
effect, and the international trade effect
• The aggregate demand curve shifts when there are changes in consumption factors (real wealth,
extended future income, taxes), investment factors (firm confidence, interest rates, the quantity
of money), government spending (at the federal, state, and local levels), or net export factors
(foreign income and the value of the U.S. dollar)
C. What is aggregate supply?
• Aggregate supply represents the producing side of the economy. It is the total supply of final
goods and services in an economy
• The long-run aggregate supply curve is relevant when all prices are flexible. This curve is
vertical at full-employment output and is not influenced by the price level
1
, • In the short run, when some prices are sticky, the short-run aggregate supply curve is relevant.
This curve indicates a positive relationship between the price level and real output supplied
D. How does the aggregate demand–aggregate supply model help us understand the economy?
• We can use the aggregate demand - aggregate supply model to see how changes in either
aggregate demand or aggregate supply (or both) affect real GDP, unemployment, and the price
level
Flow of Chapter 13
Want to answer one important question:
Q: why real GDP rises and falls and why price level rises and falls?
Study Study
Aggregate Demand Aggregate Supply
Put aggregate demand and aggregate supply together
In early 1990s
Oil prices Cost of production GDP falls
Aggregate supply
rise increases, firms decreases
v Price level rises
produce less.
2
, GDP rises back, As cost of production Because production
Aggregate
price level falls decreases, firms decreases, firms hire
supply increases
produce more. less workers, wages
____________
________
In late 2000s
Great Households do not Aggregate demand GDP falls
recession consume decreases
Price level falls
GDP rises Aggregate supply As cost of production
Because production
back, price increases decreases, firms
decreases, firms hire
level falls produce more.
less workers, wages
further
fall
A. What is the aggregate demand–aggregate supply model?
Study business cycles with Aggregate demand and aggregate supply (AD-AS) model
Aggregate demand (AD): TOTAL demand for ALL final goods and services in the economy.
Aggregate supply (AS): TOTAL supply of ALL final goods and services in the economy.
• In macroeconomics —> there are 2 major paths of study: one explores long-run growth and
development and the other examines short-run fluctuations, or business cycles
• Both are complementary —> both study GDP growth, employment, and the people, firms, and
governments that impact the economy
3
, • But —> growth economics focuses on theories and policies that affect the economic progress
over several decades whereas business cycle theory typically focuses on time horizons of 5
years or less
• The basic business cycle —> in which real GDP increases for a while during the expansionary phase
and then decreases during the contractionary, or recessionary phase
• The business cycle is most evident in real GDP growth and unemployment rates
• During recessions —> real GDP growth slows and the unemployment rate rises
• During expansions —> real GDP growth expands and the unemployment rate falls
• The model we use to study business cycles is the aggregate demand-aggregate supply (AD-AS) model
• At the core of the model at familiar concepts of supply and demand
• This considers the demand and supply of all final goods and services in an economy —> the
demand for and supply of GDP
• Aggregate Demand: is the total demand for final goods and services in an economy
• Aggregate Supply: is the total supply of final goods and services in an economy
• Aggregate means total
B. What is the aggregate demand?
GDP = C + I + G + NW
C: Spending by households
I: Borrowing and spending by firms
G: Spending by government
NX: Net spending by foreigners on U.S. goods
4
Guided notes
Chapter 13 The Aggregate Demand–Aggregate Supply Model
Big Questions to study
A. What is the aggregate demand–aggregate supply model?
• The aggregate demand-aggregate supply model is a model that economists use to study business
cycles (short-run fluctuations in the economy)
B. What is aggregate demand?
• Aggregate demand represents the spending side of the economy. It is the total demand for final
goods and services in an economy. It includes consumption, investment, government spending,
and net exports
• The slope of the aggregate demand curve is negative due to the wealth effect, the interest rate
effect, and the international trade effect
• The aggregate demand curve shifts when there are changes in consumption factors (real wealth,
extended future income, taxes), investment factors (firm confidence, interest rates, the quantity
of money), government spending (at the federal, state, and local levels), or net export factors
(foreign income and the value of the U.S. dollar)
C. What is aggregate supply?
• Aggregate supply represents the producing side of the economy. It is the total supply of final
goods and services in an economy
• The long-run aggregate supply curve is relevant when all prices are flexible. This curve is
vertical at full-employment output and is not influenced by the price level
1
, • In the short run, when some prices are sticky, the short-run aggregate supply curve is relevant.
This curve indicates a positive relationship between the price level and real output supplied
D. How does the aggregate demand–aggregate supply model help us understand the economy?
• We can use the aggregate demand - aggregate supply model to see how changes in either
aggregate demand or aggregate supply (or both) affect real GDP, unemployment, and the price
level
Flow of Chapter 13
Want to answer one important question:
Q: why real GDP rises and falls and why price level rises and falls?
Study Study
Aggregate Demand Aggregate Supply
Put aggregate demand and aggregate supply together
In early 1990s
Oil prices Cost of production GDP falls
Aggregate supply
rise increases, firms decreases
v Price level rises
produce less.
2
, GDP rises back, As cost of production Because production
Aggregate
price level falls decreases, firms decreases, firms hire
supply increases
produce more. less workers, wages
____________
________
In late 2000s
Great Households do not Aggregate demand GDP falls
recession consume decreases
Price level falls
GDP rises Aggregate supply As cost of production
Because production
back, price increases decreases, firms
decreases, firms hire
level falls produce more.
less workers, wages
further
fall
A. What is the aggregate demand–aggregate supply model?
Study business cycles with Aggregate demand and aggregate supply (AD-AS) model
Aggregate demand (AD): TOTAL demand for ALL final goods and services in the economy.
Aggregate supply (AS): TOTAL supply of ALL final goods and services in the economy.
• In macroeconomics —> there are 2 major paths of study: one explores long-run growth and
development and the other examines short-run fluctuations, or business cycles
• Both are complementary —> both study GDP growth, employment, and the people, firms, and
governments that impact the economy
3
, • But —> growth economics focuses on theories and policies that affect the economic progress
over several decades whereas business cycle theory typically focuses on time horizons of 5
years or less
• The basic business cycle —> in which real GDP increases for a while during the expansionary phase
and then decreases during the contractionary, or recessionary phase
• The business cycle is most evident in real GDP growth and unemployment rates
• During recessions —> real GDP growth slows and the unemployment rate rises
• During expansions —> real GDP growth expands and the unemployment rate falls
• The model we use to study business cycles is the aggregate demand-aggregate supply (AD-AS) model
• At the core of the model at familiar concepts of supply and demand
• This considers the demand and supply of all final goods and services in an economy —> the
demand for and supply of GDP
• Aggregate Demand: is the total demand for final goods and services in an economy
• Aggregate Supply: is the total supply of final goods and services in an economy
• Aggregate means total
B. What is the aggregate demand?
GDP = C + I + G + NW
C: Spending by households
I: Borrowing and spending by firms
G: Spending by government
NX: Net spending by foreigners on U.S. goods
4
