economics Chapter Contents

McConnell
Brue
Flynn
Aggregate Demand
Changes in Aggregate Demand
Aggregate Supply
Changes in Aggregate Supply
Chapter 32 Equilibrium in the AD-AS Model (DIY)
Aggregate Demand and Aggregate
Supply Changes in Equilibrium (DIY)

32-2
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Why do we learn AD-AS model Why do we learn AD-AS model

Imagine an economy as a big market: Understanding the AD-AS model helps explain why the economy
experiences ups and downs and how different factors like consumer
•AD is everyone walking around the market wanting to buy things.
spending, business investment, and government policies influence
•AS is all the stalls and shops in the market ready to sell things. these changes.
What happen to economy is
If lots of people want to buy more than what the stalls have, prices
will go up (inflation).
If the stalls have more products than people want to buy, prices
might go down, and some stalls might close (leading to
unemployment).
14-3 14-4
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 The Aggregate Demand Curve
Aggregate Demand (AD) is a concept that shows
1. What happen to the purchasing power if overall price drops?
how much total stuff (goods and services) (this called real balance effect)
everyone—people, businesses, and the
government—wants to buy at different price levels 2. When price drops, interest rates drop. Why ?
in an economy. (this is called interest rate effect)
Aggregate
Price level

demand
- We have extra cash. This cash we save. Banks will have more
Key Points: money in bank to lend out, with low IR to attract borrowers.
•AD Curve: It's a line or curve on a graph that shows
the amount of total output (goods and services) - Lower prices → less cash needed → more bank deposits →
people want to buy at each price level.
AD more money to lend → lower interest rates.
•Inverse Relationship: As prices go down, the total
0
Real domestic output, GDP
amount of stuff people want to buy goes up, and - How these will affect i) AD (the spending : increase/decrease?)
vice versa.
LO32.1 32-5 ii) curve ? (shift to right/left?) 14-6
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How does IR effect spending ? What about foreign purchase?

(this is called foreign purchase effect)
Low IR à More/less Borrowing à Business will invest less/more
- What if your country’s product becomes cheaper ?
(more/less export/import)
How this phenomenon affect AD curve? - How the AD curve moves (right or left)?
Right/left

14-7 14-8
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 Changes in Aggregate Demand Graphed In Short
The reason why lower prices lead to higher demand overall isn't the same as for a single product.
Increase in There’s no substitute for "everything" in the economy, and changes in income are linked to the total
aggregate output. Instead, the inverse relationship in AD is explained by three main effects:
demand
1.Real Balances Effect:
When prices drop, the money people have can buy more, so they spend more.

Price level
2.Interest Rate Effect:
Lower prices lead to lower interest rates, making borrowing cheaper. This encourages more
spending on big items like houses and cars.
AD2
Decrease in 3.Foreign Purchases Effect:
aggregate AD1
demand AD3 If U.S. prices fall compared to other countries, foreign buyers will buy more U.S. goods, and
Americans will buy fewer imports, boosting U.S. production.
0
Real domestic output, GDP
LO32.2 32-9 14-10
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What are other factors that cause AD to move Factors à C à AD

right/left? Consumer
expectation
Hint: Remember your GDP formula, think, what are the things
that affect GDP components?
Consumer wealth
Consumer AD to
Spending (C ) increase/decrease
(shift right/left)
Debt

Taxes
14-11 14-12
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 Factors à I à AD Factors à G à AD
Infra Spending
Interest Rates
Expected future
(Cost of
business condition
borrowing) AD to
Investment Taxes
Spending (I ) increase/decrease
(shift right/left) Government AD to
Technology Expected Return increase/decrease
Spending (G )
(shift right/left)
Military Expenses
Business Tax

Others
14-13 14-14
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Factors à X-M à AD Aggregate Demand

Aggregate demand a key element of the aggregate
demand–aggregate supply model (AD-AS model)
National Income Abroad Real GDP desired at each price level
Net Export (X-M ) AD to increase/decrease
(shift right/left)
Inverse relationship:
Exchange Rate
(Our money • Real balances effect
appreciates/depreciates

• Interest rate effect

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14-15 LO32.1 • Foreign purchases effect
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32-16
 The Aggregate Demand Curve Changes in Aggregate Demand
Determinants of aggregate demand: Shift factors
affecting C, I, G, Xn.
Aggregate Two components involved:

Price level
demand

1. Change in one of the determinants

2. Multiplier effect.
AD

0
Real domestic output, GDP
LO32.1 32-17 LO32.2 32-18
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Changes in Aggregate Demand Graphed Consumer Spending

Increase in
Consumer wealth
aggregate
demand
Consumer expectations
Household borrowing
Price level

Personal taxes
AD2
Decrease in
aggregate AD1
demand AD3

0
Real domestic output, GDP
LO32.2 32-19 LO32.2 32-20
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 Investment Spending Government Spending
Real interest rates Government spending increases:
Expected returns: • Aggregate demand increases (as long as interest
rates and tax rates do not change)
• Expectations about future business conditions
• More transportation projects
• Technology
Government spending decreases:
• Degree of excess capacity • Aggregate demand decreases
• Business taxes • Less military spending
LO32.2 32-21 LO32.2 32-22
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Net Export Spending Aggregate Supply

National income abroad Aggregate supply is a graph that shows how much real domestic
output is available at every price level. The relationship is based
Exchange rates: on whether the prices of inputs and outputs are set or flexible.
• Dollar depreciation Relationship depends on time horizon:
• Dollar appreciation
• Immediate short run
• Short run
• Long run
LO32.2 32-23
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 AS in Intermediate/Very short run
• This is a very short period As a business person, why can’t we change the input (salary, raw material price)
where we can't change the and output price in intermediate SR?
prices we pay for raw materials
Intermediate/very (fixed input price) and labor
SR (fixed input price), and also we 1. Because we already had agreement to pay our workers certain amount in
cannot change the price we certain duration. Remember, we already planned our budgets & cost
charged to customer (fixed
output price) 2. Because we already had agreement to buy raw materials at certain amount for
certain period.
1.Variable Output Prices:
1.You can change the prices you charge customers
for your products. If demand increases, you
Why cant we change the price of our product ?
might raise prices to make more profit. If
demand drops, you might lower prices to attract
more customers. 1. Because we already do promotion at certain price. Remember, customer like stable
Short Run
2.Fixed Input Prices: price.
1.However, many of your input costs, like wages
and some material costs, are still fixed due to
contracts. You can’t suddenly pay your workers
less or change your long-term supply
14-25 14-26
agreements.
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Aggregate Supply in the Immediate Short Run AS – in short run

In short run, variable (product) price can change BUT input price (salary, raw materia) is
fixed
WHY?
Immediate-short-run
aggregate supply
Salary: You still have a contract to pay your workers $20 per hour for the year. This cost
Price level

remains fixed until the contract is renegotiated.

P1 ASISR
•Material Costs: Suppose you have a six-month agreement to buy steel at $500 per ton.
This price stays the same until the agreement ends.
•Product Prices: You notice that demand for your gadgets is increasing, so you decide to
raise the price from $50 to $55. Conversely, if you see that fewer people are buying, you
might reduce the price to $45 to encourage more sales.
0 Qf
Real domestic output, GDP

LO32.3 32-27
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 The Aggregate Supply Curve (Short Run) AS – Long run
AS In the long run, things change significantly for our business.
Both our input and output prices, as well as your production
Aggregate supply
(short run) capacity, can change.

Price level

0 Qf
Real domestic output, GDP

LO32.3 32-29 14-30

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AS – Long run Aggregate Supply in the Long Run

1.Flexible Input Prices:
is vertical at the full-
Over the long run, you can renegotiate wages, change suppliers, or find new sources employment level of
ASLR
for materials. real GDP, Qf,
because in the long
2.Flexible Output Prices: run, wages and other
input prices rise and

Price level
You canadjust the prices of your products based on long-term trends in supply and fall to match changes
demand. in the price level. So
price-level changes Long-run
3.Full Production Capacity: do not affect firms’ aggregate
profits, and thus they supply
In the long run, you can invest in new technology, expand your factory, train your create no incentive
workers, or even move to a different location. This means you can change your total for firms to alter their
output 0 Qf
production capacity. Real domestic output, GDP

14-31 LO32.3 32-32

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 Changes in Aggregate Supply Factors à Factors à AS
Determinants of aggregate supply: Shift factors Labour
Input Price
Raw Materials
Collectively position the AS curve
Got capital?
Changes raise or lower per-unit production costs AS to
Got Labour? Resources availability
increase/decrease
Got resources? Technology
or move right/left

Productivity (efficienct or not)

Tax
Government Policies
Subsidies
LO32.4 32-33
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Changes in Aggregate Supply Graphed Input Prices

Domestic resource prices:
AS3
AS1

Decrease in
AS2 • Labor
aggregate supply
• Capital
Price level

• Land

Increase in
Prices of imported resources:
aggregate supply

0
• Imported oil
Real domestic output, GDP

LO32.4 32-35 LO32.4

• Exchange rates 32-36
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 Productivity Legal-Institutional Environment
Real output per unit of input Legal changes alter per-unit costs of output:
• Increases in productivity reduce costs • Business taxes and subsidies
• Decreases in productivity increase costs • Government regulation
total output
Productivity = total inputs

total input cost

Per-unit production cost = total output
LO32.4 32-37 LO32.4 32-38
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The Equilibrium Price Level and Equilibrium Real GDP An Increase in Aggregate Demand That Causes Demand-
Pull Inflation
AS
AS
Real Output Real Output
Price level (index numbers)

Demanded Price Level Supplied

(Billions) (Index Number) (Billions)

$506 108 $513

P2

Price level
508 104 512
100 510 100 510
a P1
b 512 96 507
92
514 92 502
AD
AD2
AD1
0 502 510 514
Real domestic output, GDP 0 Qf Q1 Q2
(billions of dollars)
Real domestic output, GDP
LO32.5 32-39 LO32.6 32-40
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 A Recession Resulting from a Leftward Shift of Aggregate Decreases in AD: Recession and Cyclical
Demand When the Price Level Is Downwardly Inflexible
Unemployment
AS
Prices are downwardly inflexible:
• Fear of price wars

Price level
P1
b
a • Menu costs
P2 c
• Wage contracts
AD1
AD2
• Efficiency wages
0 Q1 Q2 Qf

LO32.6
Real domestic output, GDP
• Minimum wage law
32-41 LO32.6 32-42
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Global Perspective 32.1 A Decrease in Aggregate Supply That Causes Cost-Push

Inflation
AS2
AS1

Price level
P2

P1 a

AD

0 Q1 Qf
Real domestic output, GDP
LO32.6 32-43
LO32.6 32-44
Source: OECD Economic Outlook, Organisation for
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 Growth, Full-Employment, and Relative Price Stability Last Word: The COVID-19 Inflation
AS1
Inflation in the Unites States had a 7 percent annual
AS2
rate in 2021—the highest since 1981.

b
This was the result of a rightward AD shift and a

Price level
P3
P2
P1 a c leftward AS shift, featuring both cost-push inflation
and demand-pull inflation.
AD2
AD1
Massive government spending pushed AD to the right,
0 Q1 Q2 Q3
Real domestic output, GDP while supply chain disruptions pulled the AS curve
LO32.6 32-45
left. 32-46
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