Aggregate Demand Curve Overview

Podcast

Play an AI-generated podcast conversation about this lesson

Questions and Answers

What does the aggregate demand curve illustrate?

The effects of fiscal policy on economic growth.

The relationship between employment rates and inflation.

The relationship between income levels and consumer spending.

The correlation between aggregate price level and quantity of aggregate output demanded. (correct)

Which factor does NOT contribute to the downward slope of the aggregate demand curve?

Changes in consumer expectations. (correct)

The interest rate effect.

The wealth effect.

The exchange rate effect on imports.

In which situation would the aggregate demand curve shift to the right?

A significant decrease in consumer wealth.

Increased optimism among consumers and firms. (correct)

A rise in the existing stock of physical capital.

Reduction in government expenditure.

What happens to planned spending if the aggregate price level increases?

It decreases at all output levels. Signup and view all the answers

What is the effect of government purchases on the aggregate demand curve?

They cause a direct shift in aggregate demand. Signup and view all the answers

How does the income-expenditure model relate to the aggregate demand curve?

It indicates that a change in price level shifts the planned spending curve. Signup and view all the answers

Why does an increase in the aggregate price level lead to a rise in interest rates?

More money is held by households, increasing money supply. Signup and view all the answers

What would typically happen to aggregate demand if the real value of household assets decreases?

Aggregate demand would decrease. Signup and view all the answers

What is indicated by a recessionary gap?

Aggregate output is below potential output Signup and view all the answers

What formula represents the calculation of the output gap?

Output gap = (Actual aggregate - Potential output) x 100 / Potential output Signup and view all the answers

Which statement best describes demand shocks?

They shift the Aggregate Demand curve affecting price levels and output in the same direction Signup and view all the answers

What dilemma arises from negative supply shocks?

Stabilizing prices requires decreasing aggregate demand, leading to higher unemployment Signup and view all the answers

What do economists recommend concerning government intervention during economic downturns?

Implement stabilization policies to restore potential output Signup and view all the answers

What was the U.S. government's approach to economic stabilization in the 1970s?

Prioritized inflation reduction at the cost of unemployment Signup and view all the answers

How do increases in production costs affect profits and supplier behavior in the short run?

Decrease profits causing suppliers to reduce production Signup and view all the answers

How is an inflationary gap defined?

Aggregate output is above potential output Signup and view all the answers

Which of the following statements regarding macroeconomic policy is true?

Active macroeconomic policy can prevent excessive expansions Signup and view all the answers

What effect does an increase in the price of a commodity have on the short-run aggregate supply curve?

It shifts the SRAS curve to the left. Signup and view all the answers

In which scenario would the short-run aggregate supply curve likely shift to the left?

A rise in nominal wages. Signup and view all the answers

What is the primary reason for the upward slope of the short-run aggregate supply curve?

Wages tend to be sticky, causing profits to rise with price level increases. Signup and view all the answers

How does a change in wealth impact movement along the aggregate demand curve?

It causes movement along the curve if due to a price level change. Signup and view all the answers

What happens to the short-run aggregate supply curve if productivity among workers increases?

The SRAS curve shifts to the right. Signup and view all the answers

In a perfectly competitive market, what is the expected producer's response when demand rises?

Producers will likely increase both prices and output. Signup and view all the answers

What is the relationship between the long-run aggregate supply curve and the aggregate price level?

There is no direct effect; all prices are flexible in the long run. Signup and view all the answers

What is the outcome in an economy when nominal wages rise due to low unemployment?

The SRAS curve shifts left. Signup and view all the answers

Which of the following is an event that can lead to a demand shock?

A sudden increase in consumer confidence. Signup and view all the answers

If the economy is in short-run macroeconomic equilibrium, what must be true?

The quantity of aggregate output supplied equals the quantity demanded. Signup and view all the answers

What characterizes the long-run aggregate supply curve, compared to the short-run aggregate supply curve?

It is vertical at the potential output level. Signup and view all the answers

What does a leftward shift of the aggregate demand curve indicate?

A decrease in consumer spending at every price level. Signup and view all the answers

What leads to a movement along the aggregate supply curve rather than a shift?

Changes in the overall price level. Signup and view all the answers

What is potential output in economic terms?

The level of real GDP when all prices are fully flexible. Signup and view all the answers

Study Notes

Aggregate Demand (AD) Curve

Represents the relationship between aggregate price level and quantity of aggregate output demanded.
Downward sloping: Higher price level leads to lower quantity demanded.
Example: A lower price level of 5 in 1933 resulted in a higher quantity demanded of $1,109 billion compared to the $817 billion demanded at a price level of 9.4.

Why is AD Curve Downward Sloping?

Wealth Effect: Higher prices reduce purchasing power, leading to reduced consumer spending.
Interest Rate Effect: Higher prices lead to higher interest rates, lowering investment and consumer spending.
Impacted variable: GDP= C + I + G + (X-IM)

AD Curve and Income-Expenditure Model

AD curve derived from income-expenditure model.
Change in aggregate price level shifts the aggregate expenditure (AEPlanned) curve.
Price drop leads to increase in planned spending at all output levels, resulting in a multiplier effect that raises Real GDP.

Shifts of AD Curve

Factors causing shifts:
- Expectations: Optimism increases, pessimism decreases aggregate spending.
- Wealth: Increased wealth increases spending.
- Existing Capital Stock: More capital leads to lower investment.
- Fiscal Policy: Changes in government purchases (G) directly shift AD. Taxes and transfers influence AD indirectly.
- Monetary Policy: Increased money supply lowers interest rates, increasing investment and consumption, thus shifting AD.

AD Curve Movement vs. Shifts

Movement along the AD curve: Change in the price level leads to movement along the curve. For example, if a price level changes and that change affects our wealth, it is a movement along the AD curve.
Shift of the AD curve: If the change in wealth doesn't stem from a change in price level, it results in a shift in the curve. For example, changes such as a housing market crash shift the AD to the left.

Aggregate Supply (AS)

Shows the relationship between aggregate price level and aggregate output supplied.
Short-run and long-run AS curves differ.

Short-Run Aggregate Supply (SRAS)

Upward sloping: Higher price level leads to higher output supplied.
Example: A fall in price level from 9.4 to 7.0 led to a decrease in output from $1,109 billion to $817 billion.
Sticky Wages: Nominal wages are slow to adjust, impacting short-run output decisions. Higher prices lead to higher profits in the short run, causing increased output.

Shifts of SRAS Curve

Factors causing shifts:
- Commodity Prices: Higher commodity prices increase production costs, shifting SRAS left.
- Nominal Wages: Higher nominal wages increase production costs, shifting SRAS left.
- Productivity: Increased productivity lowers production costs, shifting SRAS right.

Long-Run Aggregate Supply (LRAS)

Vertical: Aggregate price level has no impact on aggregate output in the long run.
Nominal wages are flexible. Therefore, equilibrium occurs when prices adjust completely.
Potential Output: Represents the level of real GDP at full employment; LRAS is determined by potential output.

LRAS Shifts

LRAS shifts when potential output changes.

Short Run to Long Run Adjustment

If the economy is not at LRAS equilibrium, wages adjust, and SRAS shifts toward the equilibrium.

AD-AS Model

Combines both AD and AS to analyze economic fluctuations.

Macroeconomic Equilibrium Points

Short-Run: Quantity of output supplied equals quantity demanded. Aggregate price level is the short-run equilibrium price level. Output is the short-run equilibrium output. Shocks can be divided into demand and supply shocks.
Long-Run: Short-run equilibrium lies on LRAS.
Output Gap: Difference between actual aggregate output and potential output. Negative gap is a recessionary gap; positive gap is an inflationary gap.

Keynes' Perspective on the Long Run

"In the long run, we are all dead." - J.M. Keynes.
Emphasizes the importance of immediate stabilization policy.

Demand Shocks

Unexpected events that shift the AD curve, affecting price and output in the same direction.

Supply Shocks

Unexpected events that shift the SRAS curve, affecting price and output in opposite directions.

Policy Responses

Demand Shocks: Policymakers may use monetary or fiscal policy to offset the shock. This can be beneficial in the short run to prevent recessions or deflation, but may have long-term costs.
Supply Shocks: Policymakers face a dilemma. Unemployment stabilization requires increased AD, potentially leading to inflation, while stabilizing prices may require reduced AD, increasing unemployment.

Macroeconomic Policy

The economy self-corrects in the long run. Governments should employ monetary and fiscal policy to achieve potential output. This is known as an active stabilization policy to offset recessions and expansions.
Short-run production costs increase, leading to lower profits-per-unit, thus causing suppliers lower output in the short run.

Studying That Suits You

Use AI to generate personalized quizzes and flashcards to suit your learning preferences.

Description

This quiz focuses on the Aggregate Demand (AD) Curve, exploring its downward-sloping nature and the factors that lead to shifts in demand. It examines the relationship between price levels and quantity of output demanded, as well as the impact of the wealth and interest rate effects on consumer spending and investment. Additionally, it covers the integration of the AD curve with the income-expenditure model.