Aggregate

Supply and
Demand
Presentation by:
April Medez
Kaye Jamayo
 AGGREGATE SUPPLY AND AGGREGATE
DEMAND MODEL
The aggregate supply – aggregate demand model is the
basic macroeconomics tool for studying output
fluctuations and the determination of the price level and
the inflation rate.

 We use this tool to understand why the economy

deviates from a path of smooth growth over time and to
explore the consequences of government policies
intended to reduce the unemployment, smooth output
fluctuations and maintain stable prices.

Aggregate supply and demand each describe a relation

between the overall price level. Aggregate supply and
demand can help us solve for the equilibrium levels of
price and output in the economy. And when a change
 AGGREGATE SUPPLY CURVE AND
AGGREGATE DEMAND CURVE

AGGREGATE SUPPLY CURVE (AS) – Describes, for

each given price level, the quantity of output firms are
willing to supply. The AS curve is upward-sloping
because firms are willing to supply more output at
higher prices.

AGGREGATE DEMAND CURVE (AD) – Shows the

combinations of the price level and the level of output
at which the goods and money markets are
simultaneously in equilibrium. The AD curve is
downward-sloping because higher prices reduce the
value of the money supply,
which reduces the demand for output.
AGGREGATE SUPPLY AND DEMAND
 TWO TYPES OF AGGREGATE SUPPLY CURVE
Classical Aggregate Supply Curve
It is vertical, indicating that the same amount of goods will be supplie
whatever the price level. The classical supply curve is based on the
assumption that the labor market is in equilibrium with full employme
of the labor force.
 eynesian aggregate supply curve
It is horizontal, indicating that firms will supply whatever
ount of goods is demanded at the existing price level. The idea underlyin
Keynesian aggregate supply curve is that because there is unemploym
ms can obtain as much labor as they want at the current wage.
 THE AGGREGATE SUPPLY CURVE AND THE PRICE
ADJUSTMENT MECHANISM

The aggregate supply curve describes the price adjustment mechanism of

the economy.
Equation (1) gives the aggregate supply curve:

Pt+1 = Pt[1+λ(Y-Y*)]

where:
Pt+1 is the price level next period
Pt is the price level today
Y* is the potential output
Y is GDP
λ is speed of price adjustment

Equation (1) embodies a very simple idea: If output

is above potential output, prices will fall and be
lower next period. What’s more, prices will continue
to rise and fall over time until output returns to
potential output. Tomorrow’s price level equals
today’s price level if, and only if, output equals
potential output.
 THE AGGREGATE DEMAND CURVE
The aggregate demand curve shows the combinations of the price
level and the level of output at which the goods and money
markets are simultaneously in equilibrium.

The quantity theory of money provides a simple way to get a

handle on the aggregate demand curve, even if it does leave out
some important elements.

EQUATION (2) = M x V = P x Y

where: P x Y = nominal GDP

V = velocity
M = money supply

If we make one additional assumption – that V is constant – then

equation (2)
turns into an aggregate demand curve. With the money supply
constant, any
 AGGREGATE DEMAND POLICY UNDER
ALTERNATIVE SUPPLY ASSUMPTIONS
THE KEYNESIAN CASE
Consider an increase in aggregate demand – such as
increased government spending, a cut in taxes or an increase in
the money supply – which shifts the AD schedule out and to the
right, from AD to AD1. The new equilibrium is at point E1, where
output has increased. Because firms are willing to supply any
amount of output at the level of prices there is no effect on
prices.
THE CLASSICAL CASE
The expansion shifts the aggregate demand schedule from AD to
AD’. At the initial level prices, P0, spending in the economy would
rise to point E’. At price level P0 the demand for goods has risen.
But firms cannot obtain the labor to produce more output, and
output supply cannot respond to the increased demand. As firms
try to hire more workers, they bid up wages and their costs of
production, so they must charge higher prices for their output.
THANK YOU!