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Before we start the lesson, read the definitions of vocabulary that will be introduced in the lesson.

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Watch Aggregate Demand Graphs.

 

Transcript

Earlier in the course, you learned that the economy goes through a business cycle. It is the interaction of the Aggregate Demand and Aggregate Supply curves, and the changes in each curve, that explain periods of growth and recession in the economy.

Watch EconEd: Aggregate Demand to learn the basics of the aggregate demand curve.

An increase in Aggregate Demand is a shift of the curve to the right (the graph on top), while a decrease in Aggregate Demand is a shift of the curve to the left (the graph on bottom).

This graph shows an increase in the aggregate demand, with the line shifting to the right. That means that at each price level, there is a higher demand. Remember, the demand curve is a downward curve, with lower demand at higher prices and higher demand at lower prices.

This graph shows a decrease in the aggregate demand, with the line shifting to the left. That means that at each price level, there is a lower demand. Remember, the demand curve is a downward curve, with lower demand at higher prices and higher demand at lower prices.

The determinants which shift the Aggregate Demand curve are summarized in the table below.

Determinant AD will shift to the right AD will shift to the left
1. Consumer Spending    
    Household Wealth Increases Decreases
    Consumer Taxes Decreases Increases
    Interest Rates Decreases Increases
    Expectations of the future The economy will perform well in the future The economy will not perform well in the future
2. Investment Spending    
    Interest Rates Decreases Increases
    Business Taxes Decreases Increases
3. Government Spending    
    Government Spending Increases Decreases
4. Net Exports    
    Net = exports - imports Exports increase or imports decrease Imports increase or Exports decrease

Watch EconEd: Aggregate Supply to learn the basics of Aggregate Supply.

Watch Aggregate Supply Graphs.


Transcript

 

An increase in Aggregate Supply is a shift of the curve to the right (the graph on top), while a decrease in Aggregate Supply is a shift of the curve to the left (the graph on bottom).

This graph shows an increase in the aggregate supply, with the line shifting to the right. That means that at each price level, there is a higher demand. Remember, the supply curve is an upward curve, with higher demand at higher prices and lower demand at lower prices.

This graph shows a decrease in the aggregate supply, with the line shifting to the left. That means that at each price level, there is a lower demand. Remember, the supply curve is an upward curve, with higher demand at higher prices and lower demand at lower prices.

The determinants which shift the Aggregate Supply curve are summarized in the table below.

Determinant AS will shift to the right AS will shift to the left
1. Cost of Inputs    
    Cost of land, labor or capital Decreases Increases
2. Government Policies    
    Subsidies Increases Decreases
    Regulations Decreases Increases
    Business Taxes Decreases Increases
3. Environmental Changes    
    Inflationary expectations Expect inflation to decrease Expect inflation to increase
    Natural Disasters   When disasters destroy businesses
4. Productivity    
    Technology Increases Decreases
    Education Increases Decreases

Watch Equilibrium Graphs.


Transcript

Putting the Aggregate Demand and Aggregate Supply curves together shows the equilibrium point of Price Level and Quantity of RGDP.

Equilibrium graph
Long description

Knowing where equilibrium begins, represented by PLe and Qe, we can now identify what happens to Price Level and Output with changes in Aggregate Demand and Aggregate Supply.

The graph below shows an increase in Aggregate Demand with Aggregate Supply staying the same.

Increase in aggregate demand graph
Long description

Identifying the new Price Level as PL1 and the new Output as Q1, we see that the price level and output have both increased. To produce more goods businesses will have to hire more workers so employment will increase.

The graph below shows an decrease in Aggregate Demand with Aggregate Supply staying the same.

Decrease in aggregate demand
Long description

Identifying the new Price Level as PL1 and the new Output as Q1, we see that the price level and output have both decreased. To produce less goods businesses will have to hire fewer workers so employment will decrease.

The graph below shows an increase in Aggregate Supply with Aggregate Demand staying the same.

Equilibrium shift with increase in aggregate supply
Long description

Identifying the new Price Level as PL1 and the new Output as Q1, we see that the price level has decreased while the output has increased. To produce more goods businesses will have to hire more workers so employment will increase.

The graph below shows a decrease in Aggregate Supply with Aggregate Demand staying the same.

Equilibrium shift with decrease in aggregate supply
Long description

Identifying the new Price Level as PL1 and the new Output as Q1, we see that the price level has increased while the output has decreased. To produce less goods businesses will hire fewer workers so employment will decrease.

It is now time to introduce the Long Run Aggregate supply curve. This graph is located below. This curve is a vertical line that represents the full employment of resources. When the economy is at equilibrium the AS and AD curves intersect over the LRAS curve, like in the graph below.

Long-Run Aggregate Supply Curve
Long description

To show graphically what a recession looks like we draw the short run equilibrium to the left of full employment. In this situation the output in the economy has decreased. With a decrease in output businesses don't need as many workers so unemployment increases. With the decrease in employment and economic activity the price level in the economy will tend to be lower. This situation is represented graphically below.

Recessionary Gap
Long description

To show graphically what inflation in an economy looks like we draw the short run equilibrium to the right of full employment. In this situation the output in the economy has increased. With an increase in output businesses have to pay more to workers and other resources since both are in short supply. In this situation price level, output and employment all increase. This situation is represented graphically below.

Inflationary gap
Long description

What factors change the LRAS curve? Generally the factors that change the SRAS curve will move the LRAS curve. The general difference is whether or not the factors have an effect for enough time to have changes take place. For instance, a bad storm that destroys businesses will cause a shift in the SRAS curve, however, it won't be long until the businesses are up and running again. Changes in the LRAS would be unlikely. On the other hand an increase in immigration will cause the SRAS curve and LRAS curve to shift. The new labor resources would add a short term and long term addition to the Aggregate Supply because of the increase in resources.

Just like with the supply curve an increase in the LRAS for a country is a shift of the LRAS curve to the right.

Rightward Movement of the LRAS Curve
Long description

A decrease in the LRAS curve is a shift of the curve to the left.

Leftward Movement of the LRAS Curve
Long description

 

If you need a review of all graphs in the lesson, watch the video below.

 

Transcript

 

 

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