ECO 102 Macroeconomics

ECO 102

Macroeconomics


Chapter
3

Aggregate Demand
and
Aggregate Supply



Prof. Dr
.
Magdy

El
-
Shourbagui


Head of the Department of Economics


College of Business & Economics


Misr

University for Science &
Technology



www.magdyel
-
shourbagui.com



1

2

Learning Objectives


Define

the

following

terms
:

aggregate

demand,

aggregate

supply,

economy’s

potential

real

GDP,

and

macroeconomic

equilibrium
.


Distinguish

between

the

aggregate

demand

curve

and

the

aggregate

supply

curve
.


Identify

and

describe

the

reasons

for

downward

slope

of

the

aggregate

demand

curve
.


Identify

and

describe

the

factors

that

shift

the

aggregate

demand

curve
.


Explain

and

illustrate

graphically

the

macroeconomic

equilibrium

in

the

short

run

3

The Meaning of Aggregate Demand

Aggregate

Demand,

AD

is

the

quantity

demanded

of

all

final

goods

and

services

(Real

GDP)

at

different

price

levels
.

AD

can

be

calculated

by

the

following

equation
:

Real GDP = Y = AD = C + I + G + NX


= C + I + G + (X
-
M)

Where
:


C

=

personal

consumption

spending,

I

=

gross

private

domestic

spending,

G

=

government

spending,

NX

=

net

exports

of

goods

and

services,

X

=

exports

of

goods

and

services,

and

M

=

imports

of

goods

and

services
.

4

The Aggregate Demand Curve

The

Aggregate

demand,

AD

curve

is

downward
-
sloping,

specifying

a

negative

relationship

between

the

price

level

as

independent

variable

and

the

quantity

of

real

GDP

demanded

as

dependent

variable
.


5

Reasons for Downward slope of the Aggregate Demand
Curve

1.
The

price

level

and

consumption

(The

Real

wealth

effect

or

the

real

money

balance

effect),


2.
The

price

level

and

investment

(The

interest

rate

effect),

and

3.
The

price

level

and

net

exports

(The

international

trade

effect)
.

6

1
.

The

price

level

and

consumption

(The

Real

wealth

effect

or

the

real

money

balance

effect),


Real

Wealth

is

the

value

of

money

in

bank,

bonds,

stocks,

and

non
-
monetary

assets

people

own

measured

in

terms

of

what

they

will

buy
.

The
price
level

the

real

purchasing

power

of

money

balances

(currency

and

bank

deposits)

and

the

real,

monetary

wealth


real wealth.

consumers feel wealthier

encourages them to spend more

quantity of goods and
services demanded

quantity

demanded

of

Real

GDP

7

2
.

The

Price

Level

and

Investment

(The

Interest

Rate

Effect)

the purchasing
power of
money

money
needed to
buy fixed
bundle of
goods and
services

the domestic
saving

supply of credit

the interest
rate

the banks will
provide more loans

spending on investment
goods by households and
businesses

8

3. The
Price Level and Net Exports (The International

Trade
Effect)

the domestic goods will be
cheaper relative to
foreign goods

Exports (X) and

Imports (M)

Net Exports (NX)

9


A

Change

in

the

Quantity

Demanded

of

the

Real

GDP
:

A

Movement

along

the

Aggregate

Demand

Curve

A change in the quantity demanded of real GDP caused by a change in the price level. It
is shown by a movement along the aggregate demand curve

10

A

Change

in

Aggregate

Demand
:

Shifts

in

the

Aggregate

Demand

Curve

A

Change

in

aggregate

demand

is

the

change

in

the

quantity

demanded

of

real

GDP

as

the

change

in

the

following

factors
:

Consumption,

investment,

government

spending,

and

net

exports
.

These

factors

will

affect

the

quantity

demanded

of

real

GDP

at

any

given

price

level
.

The

aggregate

demand

curve

shifts
,

when

one

of

the

factors

above

changes
.

11

An Increase in Aggregate Demand

An

increase

in

aggregate

demand

is

represented

by

an

outward

shift

of

the

entire

aggregate

demand

curve
.

If

aggregate

demand

increases,

greater

quantities

of

real

GDP

are

demanded

at

each

possible

price

level

for

the

year
.

12

A Decrease
in Aggregate Demand

A

decrease

in

aggregate

demand

is

represented

by

an

inward

shift

of

the

entire

aggregate

demand

curve
.

When

aggregate

demand

decreases,

a

less

quantity

of

real

GDP

is

demanded

at

each

possible

price

level

for

the

year
.

13

Factors that shift the Aggregate Demand Curve

The

aggregate

demand

curve

will

shift

as

a

result

of

changes

in

the

following
:

1.
Consumption

Spending

(C)
;

2.
Investment

Spending

(I)
;

3.
Government

Spending

(G)
;

and

4.
Net

Exports

(NX)
.

The AD curve shifts to the right side when aggregate demand increases. However,
the AD curve shifts to the left side when aggregate demand decreases.

14

1. Consumption Spending (C)

The following factors can cause consumption spending to change:

a) Consumer
Wealth;

b) Personal
Income Taxes; and

c) Expectations
about Future Income, and Inflation.

Factors that shift the Aggregate Demand Curve

a) Consumer
Wealth

Consumer Wealth

consumers feel wealthier

demand for goods

and services


by consumers

aggregate


demand

rightward shift of the

aggregate
demand
curve

Consumption

Spending

( C )

15

Factors that shift the Aggregate Demand Curve

b) Personal Income Taxes

personal income tax

disposable income of households

Consumption

Spending

( C )

aggregate


demand

rightward shift of the

aggregate
demand
curve

16

Factors that shift the Aggregate Demand Curve

c) Expectations
about Future Income, and Inflation

Consumption

Spending

( C )

aggregate

demand

rightward shift of the

aggregate
demand
curve

expected future income

the amount of consumption
goods

that people plan to
buy
today

A increase
in expected inflation

buying goods and services

cheaper
today

Consumption

Spending

( C )

aggregate

demand

rightward shift of the

aggregate
demand
curve

17

Factors that shift the Aggregate Demand Curve

2. Investment Spending (I)

The following factors can cause investment spending to change:

a) Interest
Rates;

b) Corporate
Profits Taxes; and

c) Expectations
about Future Sales.

a) Interest Rates

The
interest rates

borrowing by investors

Investment

Spending

( I )

aggregate

demand

rightward shift of the

aggregate
demand
curve

18

Factors that shift the Aggregate Demand Curve

b) Corporate Profits Taxes

Taxes
on profits of
firms

firms after
-
tax profits

Investment

Spending

( I )

aggregate

demand

rightward shift of the

aggregate
demand
curve

19

Factors that shift the Aggregate Demand Curve

c) Expectations about Future Sales

Expected
future sales

profits expectations

Investment

Spending

( I ) today

aggregate

demand

rightward shift of the

aggregate
demand
curve

20

Factors that shift the Aggregate Demand Curve

3. Government Spending (G)

An

increase

in

government

purchases

of

goods

and

services

increases

aggregate

demand
.

This

shifts

the

aggregate

demand

curve

to

the

right

4. Net Exports (NX)

The following factors can cause net exports to change:

a) Foreign
Real Income; and

b) Foreign
Exchange Rate.

21

Factors that shift the Aggregate Demand Curve

a) Foreign
Real Income

Foreign real income

(Real GDP of foreign countries)

The exports


of the home country

aggregate

demand

rightward shift of the

aggregate
demand
curve

AD = C + I + G + X
-

M


22

b) Foreign Exchange Rate

Factors that shift the Aggregate Demand Curve

Foreign exchange rate


(price of foreign currency )

The
prices of
domestic


goods and services

relative
to foreign goods
and services

Exports and

Imports

Net
exports

aggregate

demand

rightward shift of the

aggregate
demand
curve

23

The Meaning of Aggregate Supply

Aggregate

supply,

AS

is

the

quantity

supplied

of

all

final

goods

and

services

(Real

GDP)

at

different

price

levels
.

)
.

This

is

represented

by

the

aggregate

production

function
:


Y = f (N, K, L, T
)

Where:

Y =
The aggregate supply

(Real GDP);

f = depends on;

N = Labor;

K = Capital;

L = Land;

T = The State of Technology.


24

The short
-
Run Aggregate Supply Curve

The

Short
-
Run

Aggregate

Supply,

SRAS

curve

is

upward
-
sloping,

specifying

a

positive

relationship

between

the

price

level

as

independent

variable

and

the

quantity

supplied

of

real

GDP

as

dependent

variable
.


25

3.2.2.2 The
Long
-
Run Aggregate Supply
Curve
Page 75


till

Figure
3.11: A Change in Aggregate Supply
in the Short
-
Run: Shifts of the Short
-
Run
Aggregate Supply
Curve
page 81

and

3.3.2 Long
-
Run Macroeconomic
Equilibrium

page 82




Read
pages

75
till

81

26

1 Short
-
Run macroeconomic Equilibrium

When

the

quantity

demanded

of

real

GDP

equals

the

quantity

supplied

of

real

GDP,

the

Short
-
Run

macroeconomic

equilibrium

occurs


The

short
-
run

equilibrium

point

(n)

is

the

interaction

of

the

AD

curve

and

SRAS

curve
.

This

intersection

determines

the

equilibrium

price

level

(
P
e
)

and

the

equilibrium

real

GDP

(Y
e
)
.

27

28

29

30

31

32

33

34