Unit 3: Aggregate Demand and Supply and Fiscal Policy

Shifters of Aggregate Demand

AD = C + I + G + X
Change in Consumer Spending Change in Government Spending

Change in Investment Spending

Net EXport Spending

Shifters of Aggregate Supply

AS = I + R + A + P
Change in Change in Change in Change in

Inflationary Expectations Resource Prices Actions of the Government Productivity (Investment)

Practice

Answer and identify shifter:

C.I.G.X

or

R.A.P

B A D A D B A A C A A major increase in productivity.

4

Putting AD and AS together to get Equilibrium Price Level and Output

Inflationary and Recessionary Gaps

Example: Assume the government increases spending. What happens to PL and Output?
Price Level

LRAS
AS

PL1
PLe

PL and Q will Increase

AD1
7

AD QY Q1

GDPR

Inflationary Gap
Output is high and unemployment is less than NRU LRAS Price
Level

AS

PL1

Actual GDP above potential GDP

AD1 QY Q1
GDPR
8

Example: Assume the price of oil increases drastically. What happens to PL and Output?
Price Level PL1 PLe

LRAS

AS1

AS

Stagflation
Stagnate Economy + Inflation AD Q1 QY
GDPR
9

Recessionary Gap
Output low and unemployment is more than NRU LRAS AS1 Price
Level PL1

Actual GDP below potential GDP

AD Q1 QY
GDPR
10

AD and AS Practice Worksheet

11

How does this cartoon relate to Aggregate Demand?

12

Draw AD and AS at full employment

Price Level
LRAS
AS

P2 P1

AD2
AD=C+I+G+X Qf Q2 (Y*or FE) Output Increases

GDPR

PL Increases
13

Short Run and Long Run

14

Shifts in AD or AS change the price level and output in the short run
Price Level

LRAS
AS

PLe

AD QY
GDPR
15

Example: Assume consumers increase spending. What happens to PL and Output?

Price Level

LRAS
AS

PL1
PLe AD1
16

AD QY Q1

GDPR

Now, what will happen in the LONG RUN?

Inflation means workers seek higher wages and production costs increase LRAS AS1 Price
Level PL2

AS
Back to full employment with higher price level

PL1
PLe

AD QY Q1

AD1
17

GDPR

Example: Consumer expectations fall and consumer spending plummets. What happens to PL and Output in the Short Run and Long Run?
Price Level

LRAS

AS
AS1

PLe PL1 PL2 Q1 QY

AS increases as workers accept lower wages and production costs fall

AD1

AD
GDPR
18