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Aggregate Supply & Aggregate Demand

BREAKING DOWN 'Aggregate Supply'

❶The aggregate demand curve will shift down and to the right.

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What is 'Aggregate Supply'?


The way to do both simultaneously would be to increase the interest rate. As interest rates go up, investment demand and certain interest-rate sensitive consumption purchases will fall. Thus, increases in the price lead to increases the interest rate, which reduces the demand for both Consumption and Investment, and thus real output.

The interest rate effect is therefore an additional justification for the downward sloping AD curve. Domestic prices also have an impact on Net Exports NX through what is called the foreign purchases effect. Since NX are part of AD, this contributes to an inverse relationship between the price level and the demand for our real domestic output. The opposite is also true. The foreign purchases effect contributes to our argument for why the AD is downward sloping.

Anything that changes the price level triggers these three effects and is represented by movement along a given AD curve. There are other factors that influence aggregate demand besides the price level, and these factors are referred to as determinants of AD.

When these other factors change, they cause a shift in the entire AD curve and are sometimes called aggregate demand shifters. The graph below illustrates what a change in a determinant of aggregate demand will do to the position of the aggregate demand curve.

As we consider each of the determinants remember that those factors that cause an increase in AD will shift the curve outward and to the right and those factors that cause a decrease in AD will shift the curve inward and to the left.

There are several factors that could increase or decrease consumption that are unrelated to changes in the price level.

For instance, increases in consumer wealth would increase consumption at each price level and would be illustrated by a rightward shift in AD. Decreases in consumer wealth would have the opposite effect. Increases in consumer indebtedness would decrease consumption and shift the aggregate demand curve to the left, while decreases in indebtedness would have the opposite effect.

Increases in taxes will decrease consumption and shift the AD curve to the left while decreases in taxes will increase consumption and shift the AD curve to the right. Consumer expectations about the future of the economy can have a strong impact on consumptions. Optimism about the economy will increase consumption and shift the AD curve to the right, while widespread pessimism dampens consumer spending and shifts the AD curve to the left.

You can probably think of other factors that will shift the AD curve because they impact consumption independent of the price level. There are several factors unrelated to changes in the price level that could increase or decrease Investment and thereby shift the AD curve.

For instance, any change in the interest rate not brought about by a change in the price level would change the level of investment in the economy, and shift the AD curve.

Increases in the interest rate will reduce investment demand; decreases in the interest rate will increase investment demand. Business taxes can be structured to either encourage investment shifting the AD to the right or discourage investment shifting AD to the left. Technological improvements in an industry might make old equipment obsolete and stimulate investment, shifting AD to the right. Finally, like the impact of expectations on consumers, optimism or pessimism on the part of business owners can lead to increases or decreases in investment activity and shift the AD curve to the right or left.

The political process will sometimes lead to increases or decreases in the level of government spending. Increases in government spending will shift the AD curve to the right; decreases in government spending will shift the AD curve to the left. There are two important factors unrelated to the price level that could increase or decrease the level of Net Exports and thereby shift the AD Curve.

The first has to do with changes in national income abroad. As income abroad grows relative to income in the United States, foreigners are able to buy US products more easily and Americans can afford fewer foreign goods. Net exports will go up, shifting the AD curve to the right. If incomes abroad fall relative to income in the US, the AD curve will shift left due to a decrease in net exports. The second factor has to do with exchange rates, or the relative value of our currency to the currency of a trading partner.

If the value of the yen relative to the dollar changes so that it takes Yen to buy one US dollar, this will decrease the amount that Japanese citizens will buy in the US, and increase the amount that US citizens can buy in Japan.

This change in the exchange rate will cause net exports to fall and the AD curve to shift to the left. If the Japanese Yen were to appreciate relative to the dollar, net exports would rise and the AD curve would shift to the right. Return to the course in I-Learn and complete the activity that corresponds with this material. Aggregate Supply AS is a curve showing the level of real domestic output available at each possible price level.

Typically AS is depicted with an unusual looking graph like the one shown below. There is a specific reason for why the AS has this peculiar shape. The various ranges depict three different states in which the economy may find itself. The three states of the economy can all be thought of in relation to what is called the full-employment level of output, labeled Qf in the graph below.

We will now discuss each of the three ranges of the AS. In the Keynesian range of AS, we are at outputs which are substantially below Qf. This horizontal range implies an economy in severe recession or depression. Remember that Keynes wrote his General Theory during the heights of the Great Depression, so the range of AS that is associated with his name corresponds to such an economy. Assume that you were running a factory during a severe recession with high unemployment, and you decided that you would like to increase output.

You realize that, to increase output, you are going to have to employ more inputs, primarily more labor—however, a similar argument could be made about high unemployment of any of the other factors of production. You go to the factory door, open it, and find thousands of unemployed workers standing in line, wanting to work at your factory. How much would you have to pay them to get them to go to work for you?

Certainly, you would not have to pay them more than the going wage rate in the market, right? Essentially, you could hire as many unemployed resources as you would like without bidding up wages and prices, because of the substantial unemployment. The horizontal or Keynesian AS illustrates the idea of the economy being able to increase real output with no increase in the price level during periods of high unemployment.

In the long run , however, aggregate supply is not affected by the price level and is driven only by improvements in productivity and efficiency. Certain economic viewpoints, such as the Keynesian theory , assert that long-run aggregate supply is still price elastic up to a certain point.

Once this point is reached, supply becomes insensitive to changes in the price level. Aggregate demand is the total amount of goods and services demanded Aggregation is a principal involving the combination of all future Gain a deeper understanding of aggregate supply and demand, forces which raise the price of goods and services.

A new front in personal finance technology—data aggregation—seeks to make our financial lives easier. But here's why it may be stalling. Find out how the laws of supply and demand function for goods and services that are considered highly inelastic, including goods not yet discovered. Discover the four major factors that shape market trends: These areas are all linked as expected future It shows the combinations of the price level and level of the output at which the goods and assets markets are simultaneously in equilibrium.

Thus a reduction in price, which is shown in the figure, leads to an increase in the equilibrium and spending. The real money supply has a positive effect on aggregate demand, as does real government spending meaning that when the independent variable changes in one direction, aggregate demand changes in the same direction ; the exogenous component of taxes has a negative effect on it.

The slope of AD curve reflects the extent to which the real balances change the equilibrium level of spending, taking both assets and goods markets into consideration. An increase in real balances will lead to a larger increase in equilibrium income and spending, the smaller the interest responsiveness of money demand and the higher the interest responsiveness of investment demand. An increase in real balances leads to a larger level of income and spending, the larger the value of multiplier and the smaller the income response of money demand.

The AD curve is flatter the smaller is the interest responsiveness of the demand for money and larger is the interest responsiveness of investment demand. Also, the AD curve is flatter, the larger is the multiplier and the larger the income responsiveness of the demand for money. An increase in the nominal money stock leads to a higher real money stock at each level of prices. In the asset market, the decrease in interest rates induces the public to hold higher real balances.

It stimulates the aggregate demand and thereby increases the equilibrium level of income and spending. Thus, as we can see from the diagram, the aggregate demand curve shifts rightward in case of a monetary expansion.

The aggregate supply curve may reflect either labor market disequilibrium or labor market equilibrium. In either case, it shows how much output is supplied by firms at various potential price levels. The aggregate supply curve AS curve describes for each given price level, the quantity of output the firms plan to supply.

The Keynesian aggregate supply curve shows that the AS curve is significantly horizontal implying that the firm will supply whatever amount of goods is demanded at a particular price level during an economic depression. The idea behind that is because there is unemployment, firms can readily obtain as much labour as they want at that current wage and production can increase without any additional costs e. Firms' average costs of production therefore are assumed not to change as their output level changes.

This provides a rationale for Keynesians' support for government intervention. The total output of an economy can decline without the price level declining; this fact, in conjunction with the Keynesian belief of wages being inflexible downwards, clarifies the need for government stimulus. Since wages cannot readily adjust low enough for aggregate supply to shift outward and improve total output, the government must intervene to accomplish this result.

However, the Keynesian aggregate supply curve also contains a normally upward-sloping region where aggregate supply responds accordingly to changes in price level. The upward slope is due to the law of diminishing returns as firms increase output, which states that it will become marginally more expensive to accomplish the same level of improvement in productive capacity as firms grow. It is also due to the scarcity of natural resources, the rarity of which causes increased production to also become more expensive.

The vertical section of the Keynesian curve corresponds to the physical limit of the economy, where it is impossible to increase output. The classical aggregate supply curve comprises a short-run aggregate supply curve and a vertical long-run aggregate supply curve. The short-run curve visualizes the total planned output of goods and services in the economy at a particular price level.

The "short-run" is defined as the period during which only final good prices adjust and factor, or input, costs do not. The "long-run" is the period after which factor prices are able to adjust accordingly.

The short-run aggregate supply curve has an upward slope for the same reasons the Keynesian AS curve has one: The long-run aggregate supply curve is vertical because factor prices will have adjusted. Factor prices increase if producing at a point beyond full employment output, shifting the short-run aggregate supply inwards so equilibrium occurs somewhere along full employment output.

Monetarists have argued that demand-side expansionary policies favoured by Keynesian economists are solely inflationary.


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The demand curve only shows the relationship between the price and quantity. If one of the other determinants changes, the entire demand curve shifts.

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Aggregate supply (AS) is defined as the total amount of goods and services produced and supplied by an economy's firms over a specific time period at given price levels. It is usually represented. Section Determinants of Aggregate Supply The graph below illustrates what a change in a determinant of aggregate supply will do to the position of the aggregate supply curve. As we consider each of the determinants remember that those factors that cause an increase in AS will shift the curve outward and to the right and those factors that cause a decrease in AS will shift the curve upward and .

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Learn aggregate supply determinants with free interactive flashcards. Choose from different sets of aggregate supply determinants flashcards on Quizlet. Aggregate Demand is an economic measurement of the total demand for final goods and services in an economy at a specific time period. It is congruent with the laws defining the Gross Domestic Product (GDP) of a country in the long run after price.