Aggregate Demand and Supply Flashcards
Aggregate Demand
- Refers to the total of all goods and services demanded at various price levels.
- Shows the inverse relationship between the total real output and the average price level
- AD = C + I + G + (X-M)
Shifts in Aggregate Demand (Determinants)
- Consumption - total spending on domestic goods and services
- Investment - addition of capital stock to the economy by firms (replacement or induced)
- Government expenditure - at any level, depends on policies
- Exports (revenues) - domestic goods and services bought by foreign consumers
- Imports (expenditures) - goods and services bought from foreign producers
From the IB syllabus: determinants of AD
- C - consumer confidence, interest rates, wealth, income taxes, level of household indebtedness, expectations of future price level
- I - interest rates, business confidence, technology, business taxes, level of corporate indebtedness
- G - political and economic priorities, transfer payments
- (X - M) - income of trading partners, exchanges rates, trade policies
Consumer demand
- Durable goods - used/consumed over longer periods of time (usually years)
- when loans are needed, they are usually for durable goods
- Non-durable goods - used/consumed over a shorter period of time (weeks, months)
Study tip for Aggregate Demand (shifts)
Think of the money flow in the economy. Increase money flow in the economy = aggregate demand shift to the right.
Decrease money flow in the economy = agg demand shift to the left
- An increase in consumer confidence would make people spend more = agg demand shift outward
- Increase foreign income = can buy more export = more money in the circular flow in economy = agg demand shift outward
- Increase in interest rate = investors save more, spend less = less money in the circular flow in economy = agg demand shift inward
Aggregate Supply
- Refers to the total of all goods and services supplied at various price levels.
- It shows the relationship between real output and the average price level.
From the IB syllabus: determinants of SRAS
- Costs of factors of production
- Indirect taxes
Factors effecting quantity of FOP
- Land reclamation
- Increased access to supply of resources
- Discovery of new resources
- Increase in birth rate
- Immigration
- Decrease in natural rate of unemployment
- Investment
Factors effecting quality of FOP
- Technologival advancedment
- Fertilizers
- Irragation
- Education
- Training
- Appreticeship program
- R&D
Three phases of the Aggregate Supply Curve (Keynesian)
From the IB syllabus: shifts of LRAS
- Changes in the quantity and/or quality of FOP
- Improvements in technology
- Increases in efficiency
- Changes in institutions
Short run Aggregate Supply
As output nears full employment, some factors of production become scarce, leading firms to compete for these resources, which drives prices up.
Long Run Aggregate Supply
Represents the economy’s maximum output, where all resources are fully employed and cannot produce more with current technology and resources.
How can we push out the physical limit?
Increase the factors of production (i.e. discover more oil deposits)
Improve the factors of production
Promote savings (to have more funds available for investment)
Promote mobility of factors between sectors of the economy
Promote research and development to increase the level of technology
Promote the supply side (incentives, investment, innovation, entrepreneurial spirit)
Keynesian Phase 1 (Deflationary Gap)
Increase in AD and Y but no change in PL (no increase in producer costs)
Using up spare capacity
Keynesian Phase 2
Economy starts to feel inflationary pressure as FOP become scarcer and prices for FOP rise
PL rises to compensate for higher costs
Keynesian Phase 3 (inflationary gap)
If operating at full employment and AD rises the outcome is ‘purely inflationary’
No increase in output is possible, only change is in PL
The present FOP cannot produce more
