GROUP MEMBERS

MUHAMMAD SHAHROZE ILYAS

MUBEEN ABDUL SHAKOOR

ADEEL ASIF

MUHAMMAD FAHAD KHAN

AGGREGATE-DEMAND

In economics aggregate demand is

the total demand for final goods

and services in the economy at a

given time and price level.

Aggregate demand is the gross

domestic product of a country

when inventory levels are static

Aggregate Demand

The sum of all expenditure in the economy over a period of time

Macro concept – WHOLE economy

Formula:

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

◦ C= Consumption Spending

◦ I = Investment Spending

◦ G = Government Spending

◦ (X-M) = difference between spending on imports and receipts from exports (Balance of Payments)

Aggregate Demand –Key

Variables Consumption Expenditure

Investment Expenditure

Government Expenditure

Import Spending

Export Earning

Consumption Expenditure

Exogenous factors affecting consumption:

◦ Tax rates

◦ Incomes – short term and expected income over lifetime

◦ Wage increases

◦ Credit

◦ Interest rates

◦ Wealth

Property

Shares

Savings

Bonds

Investment Expenditure

Spending on:

◦ Machinery

◦ Equipment

◦ Buildings

◦ Infrastructure

Influenced by:

◦ Expected rates of return

◦ Interest rates

◦ Expectations of future sales

◦ Expectations of future inflation rates

Government Spending

Defence

Health

Social Welfare

Education

Foreign Aid

Regions

Industry

Law and Order

Import Spending (negative)

Goods and services bought from

abroad – represents an outflow of

funds from the country (reduces AD)

Export Earnings (Positive)

Goods and services sold abroad –

represents a flow of funds into the

country (raises AD)

Aggregate Demand Curve

The aggregate

demand (AD)

curve is a curve

that shows the

negative

relationship

between aggregate

output (income)

and the price level

Deriving the Aggregate Demand

Curve

To derive the aggregate demand

curve, we examine what happens to

aggregate output (income) (Y) when

the price level (P) changes, assuming

no changes in government spending

(G), net taxes (T), or the monetary

policy variable (Ms).

Deriving the Aggregate Demand

Curve The AD curve is

not a market

demand curve, and

it is not the sum of

all market demand

curves in the

economy. It is a

more complex concept.

Aggregate Demand Curve

Aggregate demand falls when the price level increases because the higher price level causes the demand for money to rise, which causes the interest rate to rise.

It is the higher interest rate that causes aggregate output to fall.

At all points along the AD curve, both the goods market and the money market are in equilibrium.

Reasons why AD is downward

sloping The consumption link: The

decrease in consumption brought

about by an increase in the interest

rate contributes to the overall

decrease in output.

The real wealth effect, or real

balance, effect: When the price level

rises, there is a decrease in

consumption brought about by a

change in real wealth.

Shifts in AD

Changes in

Governmental

Policies

Changes in Monetary

Policy

Changes in

Expectations of

Households and

Firms

Factors that Effect Aggregate

Demand 1. Income

2. Wealth

3. Population

4. Interest rates

5. Credit availability

6. Government demand

7. Taxation

8. Foreign demand

9. Investment

10. Expectations

(a) Inflationary

(b) Income

(c) Wealth

(d) Interest rate

(+)

(+)

(+)

(–)

(+)

(+)

(–)

(+)

(+)

(+)

(+)

(+)

(+)

AGGREGATE

SUPPLY

AGGREGATE

SUPPLY

Aggregate supply is the total

supply of goods and services

in an economy.

AGGREGATE SUPPLY

CURVECurve shows relation between

aggregate quantity of output supplied by

all the firms in an economy and overall

price level.

It is not a market supply curve ,and it is

not simple sum of all individual supply

curves.

Rather than an aggregate supply curve,

what does exist is a “price/output

response” curve

AGGREGATE SUPPLY IN

THE SHORT RUN

In the short run, the

aggregate supply curve

(the price/output

response curve) has a

positive slope

AGGREGATE SUPPLY IN THE

SHORT RUN

Macroeconomists focus on whether or

not the economy as a whole is operating

at full capacity.

As the economy approaches maximum

capacity, firms respond to further

increases in demand only by raising

prices.

AGGREGATE SUPPLY IN THE

SHORT RUN

At low levels of

aggregate output the

curve is fairly flat.

As economy

approaches capacity, the

curve becomes nearly

vertical.

At capacity, the curve

is vertical.

The Response of Input Prices to

Changes in the Overall Price

Level

There must be a lag between changes in input prices and changes in output prices, otherwise the aggregate supply (price/output response) curve would be vertical.Wage rates may increase at exactly the same rate as the overall price level if the price-level increase is fully anticipated. Most input prices, however, tend to lag increases in output prices.

WHY IS THE SHORT RUN

CURVE UPWARD SLOPING?Short-run aggregate supply curve slopes

upward because:

Contracts make some wages and

prices “sticky.”

Firms are often slow to adjust wages.

Menu costs make some prices sticky

Shifts of the Short-Run

Aggregate Supply Curve

A decrease in aggregate

supply

An increase in aggregate

supply

Bad weather, natural

disasters, destruction

from wars

Good weather

Public policy

waste and inefficiency

over-regulation

Public policy

supply-side policies

tax cuts

deregulation

Stagnation

capital deterioration

Economic growth

more capital

more labor

technological change

Higher costs

higher input prices

higher wage rates

Lower costs

lower input prices

lower wage rates

Shifts to the LeftDecreases in Aggregate Supply

Shifts to the RightIncreases in Aggregate Supply

Factors That Shift the Aggregate Supply Curve

Shifts of the Short-Run

Aggregate Supply Curve

The Equilibrium Price Level

AD represents money

and goods market in

equilibrium.

AS represents

price/output decisions of

all firms in ecomony.

P0 and Y0 correspond to

equilibrium in the goods

market and the money

market and a set of

price/output decisions on

the part of all the firms in

the economy.

The Long-Run

Aggregate Supply Curve

Costs lag behind price-level changes in the short run, resulting in an upward-sloping AS curve.

Costs and the price level move in tandem in the long run, and the AS curve is vertical.

The Long-Run

Aggregate Supply Curve

Output can be

pushed above

potential GDP by

higher aggregate

demand. The

aggregate price level

also rises.

The Long-Run

Aggregate Supply Curve

When output is pushed above potential, there is upward pressure on costs, and this causes the short-run AS curve to the left.

Costs ultimately increase by the same percentage as the price level, and the quantity supplied ends up back at Y0.

The Long-Run

Aggregate Supply Curve

Y0 represents the level of output that can be sustained in the long run without inflation. It is also called potential output orpotential GDP.

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