Economics - Aggregate Demand and Aggregate Supply - Quick Guides | Economics

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Study GuideEconomics–Aggregate Demand and Aggregate Supply1. Aggregate Demand (AD) Curve1.1What Is Aggregate Demand?In macroeconomics, we do not study just one product at a time. Instead, we look at theentireeconomy.So, the demand forall goods and services togetheris calledaggregate demand (AD).In the same way, the supply of all goods and services together is calledaggregate supply (AS).Just like individual demand and supply,aggregate demand and aggregate supplycan be shownusing:•a table (schedule),•a graph (curve), or•a mathematical equation.1.2The Aggregate Demand CurveTheaggregate demand curveshows thetotal quantity of goods and servicesthat people arewilling to buy in an economyat different price levels.

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Study GuideUnderstanding the Axes•Vertical axis (Y-axis):Price level of all final goods and servicesoMeasured using theGDP deflatororConsumer Price Index (CPI)•Horizontal axis (X-axis):Real GDPoMeasures thetotal outputof goods and services in the economy1.3Why Is the Aggregate Demand Curve Downward Sloping?The aggregate demand curve slopesdownward from left to right.This means:•When theprice level falls,real GDP demanded increases•When theprice level rises,real GDP demanded decreasesImportant point:Thereasons for this downward slope are differentfrom the reasons behind the downward slope ofdemand for a single product.

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Study Guide1.4Why Individual Demand Logic Does Not Apply HereFor asingle good, we assume:•prices of other goods stay the same•consumer income stays the sameBut foraggregate demand:•many prices change together•wages also change•incomes change as wellBecause of this, wecannot use the same explanationas individual demand curves.Instead, there arethree special effectsthat explain the downward slope of the AD curve.1.5Three Reasons for the Downward-Sloping AD Curve1. Wealth Effect•The government keeps themoney supply constant•Money represents thewealth of the economyWhen theprice level rises:•purchasing power of money falls•people feel poorer•spending on goods and services decreasesWhen theprice level falls:•purchasing power of money rises•people feel wealthier•spending increases

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Study Guide2. Interest Rate Effect•Higher prices mean households and firms needmore money for transactions•But themoney supply is fixedAs demand for money increases:•interest rates riseHigher interest rates:•reduce investment and borrowing•lower spending on interest-sensitive goods3. Net Exports Effect•When domestic prices rise:oforeign goods become cheaper → imports increaseodomestic goods become more expensive abroad → exports decreaseNet exports = Exports − ImportsWhen imports rise and exports fall,net exports decreaseSince net exports are part of GDP, real GDP demanded falls as prices rise.

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Study Guide1.6Changes in Aggregate Demand (Shifts in the Curve)Rightward Shift (AD₁→ AD₂)•More real GDP is demandedat the same price level•Indicates economic expansionLeftward Shift (AD₁→ AD₃)•Less real GDP is demandedat the same price level•Indicates economic slowdown or recession1.7What Causes Shifts in Aggregate Demand?Important:Aggregate demanddoes NOT shiftbecause of changes in the price level.Instead, it shifts due to changes in:

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