• Aggregate demand is made up of four components: consumption, investment, government spending, and net exports (exports minus imports).
• Consumption is the largest component of aggregate demand and represents the spending of households on goods and services.
• Investment represents the spending of businesses on capital goods such as machinery, equipment, and buildings.
• Government spending represents the spending of the government on goods and services
• Net exports represent the difference between exports and imports.

• Consumer confidence plays a key role in determining aggregate demand.
  • If consumers are optimistic about the future, they are more likely to spend, and this increased spending will boost aggregate demand.
  • If consumers are pessimistic, they may save more and spend less, which will decrease aggregate demand.
• Interest rates have a significant impact on aggregate demand.
  • When interest rates are low, borrowing becomes more affordable, and this increases spending on investment, consumption, and housing. As a result, aggregate demand increases.
  • When interest rates are high, borrowing becomes less affordable, and this decreases spending on investment, consumption, and housing, which results in a decrease in aggregate demand.
• Government spending can have a significant impact on aggregate demand.
  • An increase in government spending will raise aggregate demand, while a decrease in government spending will decrease aggregate demand.
• Exchange rates can impact aggregate demand by affecting the prices of exports and imports.
  • A depreciation of the domestic currency makes exports cheaper, which increases exports and aggregate demand.
  • An appreciation of the domestic currency makes exports more expensive, which decreases exports and aggregate demand.
• Taxation can impact aggregate demand by affecting the disposable income of households and businesses.
  • An increase in taxes will reduce disposable income, which will decrease spending and aggregate demand.
  • A decrease in taxes will increase disposable income, which will increase spending and aggregate demand.

• Aggregate demand is represented graphically as a downward-sloping curve, with the amount of aggregate demand increasing as the price level decreases.
• The slope of the aggregate demand curve is determined by the responsiveness of the components of aggregate demand to changes in the price level.
  • When the price level decreases, the amount of aggregate demand increases, which can lead to an increase in output, employment, and income in the short run.
  • When the price level increases, the amount of aggregate demand decreases, which can lead to a decrease in output, employment, and income in the short run.

Any change in the determinants of AD can cause a shift in the AD curve.

• consumer confidence,
• interest rates,
• government spending,
• exchange rates,
• taxation

• Aggregate supply (AS) is a measure of the total amount of goods and services that firms in an economy are willing and able to produce and sell at a given price level over a specified period of time.
• It represents the relationship between the price level and the quantity of output that firms are willing to supply.

• Input prices: Changes in the prices of factors of production such as labor, capital, and raw materials can affect the cost of production and thus, the supply of goods and services. If input prices increase, firms will face higher costs and the aggregate supply curve will shift to the left.

   

• Technology: Technological advancements can increase productivity and efficiency, leading to an increase in aggregate supply. Technological innovations can reduce the cost of production and increase the output of goods and services.

   

• Production capacity: The production capacity of an economy, represented by the stock of physical capital and the level of technology, affects aggregate supply. An increase in production capacity can lead to an increase in aggregate supply.

   

• Government policies: Government policies, such as tax and regulatory policies, can impact the level of aggregate supply. For example, if the government imposes new regulations or raises taxes, the cost of production for firms may increase, resulting in a decrease in aggregate supply.

   

• Natural disasters: Natural disasters such as hurricanes, earthquakes, and droughts can disrupt production and reduce aggregate supply.

   

• Expectations: Expectations about future economic conditions and prices can impact the aggregate supply of an economy. For example, if firms expect that prices will rise in the future, they may be more willing to increase production today, which will lead to an increase in aggregate supply.

• In the short run, the AS curve is upward sloping because firms are unable to change the amount of capital and other fixed inputs they use in production, so as prices increase, firms will try to produce more to take advantage of the higher prices. This increase in output leads to an increase in aggregate supply.
• In the long run, the AS curve is vertical because all inputs, including the amount of capital and labor, can be adjusted in response to changes in demand and prices.
  • As prices increase in the long run, firms can increase their costs of production, including the amount of capital and labor they use. This increase in costs results in a decrease in profit margins, which will encourage firms to reduce their production.
  • The long-run aggregate supply curve is vertical because the increase in costs offsets the increase in prices, leaving the aggregate supply unchanged.

Short-Run Aggregate Supply (SRAS) Curve Shift:

• Changes in input prices, such as the price of labor or raw materials, can cause a shift in the SRAS curve.
  • For example, if the price of oil increases, the cost of production for firms will also increase, causing the SRAS curve to shift to the left.
• Expectations about future prices and economic conditions can also impact the SRAS curve.
  • For example, if firms expect prices to increase in the future, they may be more willing to increase production in the short run, which will cause the SRAS curve to shift to the right.

Long-Run Aggregate Supply (LRAS) Curve Shift:

• Capital and labor: Changes in the stock of capital and the quantity of labor can cause a shift in the LRAS curve.
  • For example, if there is an increase in investment, the stock of capital will increase, causing the LRAS curve to shift to the right.
• Natural disasters: Natural disasters, such as earthquakes or hurricanes, can disrupt production and reduce the LRAS curve.
• Institutional changes: Changes in institutional factors, such as tax policies or regulations, can impact the LRAS curve.
  • For example, if the government implements policies to encourage investment and entrepreneurship, the LRAS curve may shift to the right.
• Productivity: Changes in productivity, or the efficiency with which inputs are used to produce output, can also impact the LRAS curve.
  • For example, if an economy experiences a technological breakthrough, productivity will increase, causing the LRAS curve to shift to the right.

• A movement along the aggregate demand (AD) curve and the aggregate supply (AS) curve refers to a change in the quantity demanded or supplied due to a change in the price level, with all other factors remaining constant.
  • This is represented as a movement along a fixed curve.
• A shift in the AD curve, on the other hand, occurs when there is a change in one of the determinants of aggregate demand, such as consumer spending, investment, government spending, or net exports, causing the entire curve to move either to the right or to the left.
• A shift in the AS curve occurs when there is a change in one of the determinants of aggregate supply, such as input prices, technology, expectations, capital and labor, natural disasters, or institutional changes, causing the entire curve to move either to the right or to the left.

• In the AD/AS model, the intersection of the aggregate demand (AD) and aggregate supply (AS) curves determines the equilibrium level of real output, the price level, and employment.
  • This intersection represents the market clearing point where the quantity of goods and services supplied is equal to the quantity demanded.
• At the equilibrium point, the economy is operating at its full potential and there is no excess supply or demand in the market.
  • The real output level represents the maximum amount of goods and services that can be produced given the existing resources and technology.
  • The price level is determined by the supply and demand for goods and services in the economy.
  • The level of employment is determined by the level of real output and the labor market conditions.
• If there is an excess demand for goods and services in the economy, the price level will increase, causing a movement upward along the AS curve and further increasing the real output level.
• If there is an excess supply of goods and services, the price level will decrease, causing a movement downward along the AS curve and decreasing the real output level.
• The economy will continue to adjust until the AD and AS curves intersect and reach the equilibrium level of real output, the price level, and employment.

Shifts in the aggregate demand (AD) curve and the aggregate supply (AS) curve can have significant effects on the level of real output, the price level, and employment in an economy.

• A shift in the AD curve to the right represents an increase in aggregate demand and can lead to higher real output, higher prices, and increased employment.
• A shift in the AD curve to the left represents a decrease in aggregate demand and can result in lower real output, lower prices, and reduced employment.

   

• A shift in the aggregate supply (AS) curve to the right represents an increase in aggregate supply and can lead to higher real output, lower prices, and increased employment.
• A shift in the AS curve to the left represents a decrease in aggregate supply and can result in lower real output, higher prices, and reduced employment.

   

• It is important to note that the effect of shifts in the AD and AS curves on real output, the price level, and employment will depend on the size and direction of the shifts, as well as the level of spare capacity in the economy.
  • If there is large spare capacity in the economy, a shift in the AD curve to the right, representing an increase in aggregate demand, will result in increased real output, a small increase in prices, and increased employment.
    • This is because the economy has the capacity to produce more goods and services in response to higher demand. The increase in real output will push up the price level, as firms respond to higher prices by increasing production. The increase in employment will reflect the need for additional workers to produce the higher level of output.

       

  • If the economy is operating close to full capacity, a shift in the AD curve to the right will lead to a more modest increase in real output and a larger increase in prices.
    • This is because the economy is unable to respond to the increase in demand with a corresponding increase in supply. Firms will respond to the higher demand by raising prices, but will not be able to increase production significantly.