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Aggregate Demand and Aggregate Supply

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❶Revenue Recognition Special Cases 6. Initially there is an excess demand for goods A to B evidenced by a depletion of inventories.

Aggregate Supply




Net investment, technology changes that yield productivity improvements, and positive institutional changes can increase both short-run and long-run aggregate supply. Institutional changes, such as the provision of public goods at low cost, increase economic efficiency and cause aggregate supply curves to shift to the right. Supply Shocks - Supply shocks are sudden surprise events that increase or decrease output on a temporary basis.

Examples include unusually bad or good weather or the impact from surprise military actions. Unless the price changes reflect differences in long-term supply, the LAS is not affected.

Changes in Expectations for Inflation - If suppliers expect goods to sell at much higher prices in the future, their willingness to sell in the current time period will be reduced and the SAS will shift to the left. The Aggregate Demand Curve The aggregate demand curve shows, at various price levels, the quantity of goods and services produced domestically that consumers, businesses, governments and foreigners net exports are willing to purchase during the period of concern.

The curve slopes downward to the right, indicating that as price levels decrease increase , more less goods and services are demanded. Factors that can shift an aggregate demand curve include: Real Interest Rate Changes - Such changes will impact capital goods decisions made by individual consumers and by businesses.

Lower real interest rates will lower the costs of major products such as cars, large appliances and houses; they will increase business capital project spending because long-term costs of investment projects are reduced. The aggregate demand curve will shift down and to the right. Higher real interest rates will make capital goods relatively more expensive and cause the aggregate demand curve to shift up and to the left.

Changes in Expectations - If businesses and households are more optimistic about the future of the economy, they are more likely to buy large items and make new investments; this will increase aggregate demand. The Wealth Effect - If real household wealth increases decreases , then aggregate demand will increase decrease Changes in Income of Foreigners - If the income of foreigners increases decreases , then aggregate demand for domestically-produced goods and services should increase decrease.

The net result will be an increase decrease in aggregate demand. Inflation Expectation Changes - If consumers expect inflation to go up in the future, they will tend to buy now causing aggregate demand to increase.

If consumers' expectations shift so that they expect prices to decline in the future, t aggregate demand will decline and the aggregate demand curve will shift up and to the left. A new front in personal finance technology—data aggregation—seeks to make our financial lives easier. But here's why it may be stalling. Understand how the relationship between short- and long-term interest rates contributes to an inverted yield curve — a noteworthy economic event.

Neither big oil companies nor consumers are responsible for oil prices: The inverted yield curve has correctly predicted past recessions in the U. However, that prediction model may fail in the current scenario. Assume again that you are running a factory, only this time, the economy is at full-employment. You go to the factory door and open it to find nobody waiting in line. There does not appear to be anyone looking for a job because everyone already has one!

How much are you going to have to pay these workers to get them to do that? Most likely you will have to pay them more than they are currently making. As you bid up wages in the labor market to attract additional workers, prices in the economy will also rise, because now it costs more to produce your product. That additional cost is passed to the consumer in the form of higher prices, to the extent possible.

Attempts to increase output in the Classical Range leads to higher price levels in the economy but what about real GDP? Does it actually increase? Well, your output may go up, but the output of the factory where your new workers used to work will go down, so the overall output in the economy stays the same at Qf.

In the Intermediate Range, we are at output levels that are below full employment, but not so far below as to constitute a deep recession or depression. In this range, increasing output is possible, but only at the expense of rising prices. While that Keynesian Range is a rare short-run occurrence, and the Classical Range is the long-run steady state of the economy, the Intermediate Range is probably where we find ourselves most often in the economy.

Depending on the state of the economy, any attempt to change the output of the economy will move us along a given AS curve. There are factors that influence aggregate supply, illustratable by shifting the AS curve—these factors are referred to as determinants of AS. When these other factors change, they cause a shift in the entire AS curve and are sometimes called aggregate supply shifters.

The graph below illustrates what a change in a determinant of aggregate supply will do to the position of the aggregate supply curve. As we consider each of the determinants remember that those factors that cause an increase in AS will shift the curve outward and to the right and those factors that cause a decrease in AS will shift the curve upward and to the left.

Anything that causes input prices to rise will decrease AS and shift the AS curve to the left. Anything that causes input prices to fall will increase AS and shift the AS curve to the right. For instance, if a particular input into the production process is readily available from domestic suppliers, it will generally be cheaper, holding all else constant cet. If for no other reason, transportation costs of delivering a domestic resource to a domestic producer will be less than delivering the identical resource from a foreign supplier.

That does not even take into account the problems of getting a foreign resource such as duties and tariffs, political or social instability abroad, or other international disruptions. Another factor that can influence input prices would be the market power of the suppliers of the resource. The more competition in the supply of a resource, the cheaper that resource will be, cet.

If the resource is supplied by a monopolist or a cartel think OPEC oil , the price of that resource will be higher than if the resource is supplied by a more competitive industry think corn-produced ethanol. Independent of its price, anything that makes resources more productive will increase AS and shift the AS curve to the right; anything that makes resources less productive will decrease AS and shift the AS curve to the left. If workers become more productive because of investments in physical or human capital, the economy will be able to produce more and the AS curve will shift to the right.

If workers become less productive because of outmoded equipment, insufficient training, or excessive union interference in their workplace, the economy will be less productive, and the AS curve will shift to the left. In brief, business taxes increase the cost of production and shift the AS curve to the left; subsidies decrease the cost of production and shift the AS curve to the right. Government regulations also influence the costs of production. What does the equilibrium between AD and AS determine?

Equilibrium is illustrated below as the intersection between AD and AS. Notice that in the intermediate range, there is a tradeoff between two of the key economic variables that concern US citizens: Typically, we would like both inflation and unemployment to be low.

In the intermediate range, however, if we increase AD, inflation will go up as unemployment falls notice that if real GDP is going up, unemployment is going down: On the other hand, if we decrease AD, inflation will fall but unemployment will rise. There is no way to simultaneously decrease inflation and decrease unemployment using demand side shifts.

Do you think that decreases in AD have exactly the opposite effects as the increases? Why do you think that prices would go up very easily but fall only slowly? Part of the answer has to do with the fact that it actually costs businesses money to change their prices think of printing new catalogs, printing new menus, recoding prices in a computer and on scanners, or sending a worker out to change the prices on a marquee. It is worth it to the business to incur this expense when the price is going up, but when the price is going down they are hesitant to take on the expense of changing prices!

During the s, a variety of factors shifted the AS curve to the left. The high inflation that was combined with a stagnant economy low levels of output and high unemployment gave rise to the term Stagflation. When Ronald Reagan was elected President in , the inflation rate was Reagan employed supply side policies that were designed to shift the AS curve to the right and reduce both inflation and unemployment simultaneously. Only by supply side policies can you decrease both inflation and unemployment at the same time.

By the time that Reagan left office eight years later, the inflation rate in the economy was 4. When the AD curve intersects the AS curve in the Keynesian Range or in the Intermediate Range such that output is below Qf, there exists what is called a recessionary gap.

The gap represents the amount of government spending that would be necessary to shift the AD to the right enough to bring output to Qf. In the Keynesian Model, the magnitude of the shift in AD will depend on the size of the multiplier.

For example, if the multiplier is 2. So if the AD needs to be shifted to the right by million dollars to get to Qf and the multiplier is 2. Conversely, if the AD needs to be shifted to the left to get to Qf, there is an inflationary gap and the same multiplier principles would apply.

The changes in government spending that would close an inflationary or recessionary gap are applications of fiscal policy, which is the topic of our next lesson. Expectations about the agent's own price are derived by that agent based on observations about the general price level: An equation for short-run Aggregate Supply AS can be defined as:.

In time these economic agents will discover that the price of their particular good has not changed relative to the price of other goods in the economy. These agents will discover that they have made incorrect production decisions i.

In summary, the only way a change in the price level can affect supply production decisions in an aggregate economy is if the price level ' P ' exceeds that expected ' E[P] ' by individual producers. Ultimately changes in potential output are the result of changes in the available of resources or productivity and technology.

In the Long Run this ability to produce is based on the level of production technology and the availability of factor inputs.


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Aggregate supply determinants are held constant when the aggregate supply curves are constructed. A change in any of these determinants causes a shift of either the short-run aggregate supply curve, the long-run aggregate supply curve, or both.

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Determinants of Aggregate Supply Changes in labor force: Anything that causes the amount of workers to increase in an economy will cause aggregate supply to increase or shift to the right. If the labor force decreases, the overall supply of .

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Start studying Determinants of Aggregate Demand and Supply. Learn vocabulary, terms, and more with flashcards, games, and other study tools. These aggregate supply shifters include Changes in Resource Prices, Changes in Resource Productivity, Business Taxes and Subsidies, and Government Regulations. Let’s consider each in turn. Section Determinants of Aggregate Supply. The graph below illustrates what a change in a determinant of aggregate supply will do to the .

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