Unit 3: Aggregate Demand and Supply Flashcards
Aggregate demand/supply
Just as demand and supply explains how equilibrium is established in individual markets, aggregate demand and supply explains how equilibrium is established in a country’s economy (macroeconomics)
In theory,
if we could add up all consumer demand, at all the various price levels, for all markets, we should be able to determine the total demand schedule for an economy
By the same token, if we could add up
all of what producers are willing to supply, at all the various price levels, for all markets, we should be able to determine the total supply schedule for an economy
Aggregate Demand:
The total demand for all goods and services produced in a society
To the right is the aggregate demand schedule for a particular economy
It shows the total amount of goods and services (GDP) purchased at each price level (chain Fisher volume index)
Combining all markets for individual goods and services in a society looks at the aggregate of the econom
looks at the aggregate of the economy
AD
When aggregate demand is plotted, the curve is similar to the demand curves for individual markets
As price levels rise, the aggregate quantity demanded falls
Aggregate demand at each of the price levels is equivalent to the GDP that would occur at that price level
AD -
GDP is the sum of all consumption, investment, spending and net exports in the economy
GDP = C + I + G + (X - M)
For real economic growth to occur, real GDP must grow
Aggregate quantity demanded must increase at each price level
One or more variables of the GDP formula must increase in value
Aggregate Supply
the total supply of all goods and services produced in a society
To the right is the aggregate supply schedule for the same economy
It shows the total amount of goods and services (GDP) that would be supplied at each price level (chain Fisher volume index)
AS - 2
Difference #2
At higher output levels, prices tend to rise much more rapidly, eventually reaching perfect inelasticity (vertical)
As more output is produced, more competition occurs among producers for limited resources
Resources are no longer sitting idle, but are now running out
As resources become scarcer, prices for them go up, causing production costs to rise, increasing the prices of all goods and services
At a certain point, any attempt to increase production would simply result in increasing production costs without producing any more output
This results in perfect inelasticity
This is the point of production that is not possible without improvements in technology or discovery of new resources
AS -
The aggregate supply curve has important differences with the supply curve for individual markets
Difference #1:
At low price levels, the curve is very elastic (it doesn’t change much)
At very low outputs, society’s resources are sitting idle, and there is very little increase in average cost as those resources are put to use
Example: Labour
When there are many people unemployed, there is too little competition for workers among producers to force the price of wage labour higher (surpluses force price down)
As a result, there is little increase in production costs when workers are hired and output is increased
Output would therefore stay fairly low as output increases
Equilibrium Output and Price Level
The point at which the AD curve intersect the AS curve is the equilibrium level of price and output for the economy
When the economy is at full-employment equilibrium, the two curves intersect at a point on the AS curve where prices begin to rise more rapidly, but the curve is not yet vertical
As an economy approaches full employment, competition for resources starts to push price levels up
At some point, the curve would become vertical as an absolute capacity is reached
Full-employment is the point at which price levels start to rise more quickly, but below the absolute capacity of the economy
Recessionary Gap
the gap between aggregate demand and full employment equilibrium characterized by high unemployment, low inflation, and low GDP growth
Recessionary Gap
Below full employment equilibrium occurs when the AD curve intersects AS to the left of full-employment equilibrium
Real GDP is lower
Price levels rise very slowly (low inflation)
Low level of output results in higher unemployment
Inflationary Gap
Above full employment equilibrium occurs when the AD curve intersects AS to the right of full-employment equilibrium
Real GDP is very high
Low unemployment
Price levels rise rapidly (high inflation)
Inflationary Gap: the gap between aggregate demand and full employment equilibrium characterized by high inflation, low unemployment, and high GDP growth
Changes in Aggregate Demand and Supply
Just as with demand and supply in individual markets, there are changes in economic activity that can cause either aggregate demand or aggregate supply curves to shift left or right
