Fluctuations in aggregate supply and demand

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Intros
Lessons
  1. Increase in Aggregate Demand
    • Shifts to the right
    • Price level increase
    • Inflationary gap
    • Demand Higher Money Wage
  2. Decrease in Aggregate Demand
    • Shifts to the Left
    • Price level Decrease
    • Recessionary Gap
    • Lower Money Wage
  3. Decrease in Aggregate Supply
    • Temporary Increase in Price
    • Supply Shifts to Left
    • Stagflation
  4. Increase in Aggregate Supply
    • Temporary Decrease in price
    • Supply Shifts to Right
    • Economic Growth, Deflation
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Examples
Topic Notes
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Recall that real GDP fluctuates around potential GDP.

Fluctuations in Aggregate Supply and Demand


One reason for this is due to the fluctuations (increase/decrease) in aggregation demand and supply. In this section, we will examine each type of changes in aggregate demand and aggregate supply.

Increase in Aggregate Demand

Suppose the aggregate demand increases from a rise in world exports. What effects does it have?

Short-run Effect: The aggregate demand shifts to the right.

Fluctuations in Aggregate Supply and Demand


We notice from the new equilibrium that real GDP > potential GDP, and the price level has increased. We have an inflationary gap.

Long-run Effect: With high price levels, the workers demand higher money wage rate to have a higher purchasing power. The aggregate supply shifts to the left.

Fluctuations in Aggregate Supply and Demand


The new equilibrium gives us back real GDP = potential GDP, but price level has increased. In other words, we have inflation.

Decrease in Aggregate Demand

Suppose the aggregate demand decreases from a decrease in world exports. What effects does it have?

Short-run Effect: The aggregate demand shifts to the left.

Fluctuations in Aggregate Supply and Demand


We notice from the new equilibrium that real GDP < potential GDP, and the price level has decreased. We have a recessionary gap.

Long-run Effect: With low price levels, firms would want to decrease the money wage rate of workers. The aggregate supply shifts to the right.

Fluctuations in Aggregate Supply and Demand


The new equilibrium gives us back real GDP = potential GDP, but price level has decreased. In other words, we have deflation.

Decrease in Aggregate Supply

Suppose aggregate supply decreases from a temporary increase in the prices of oil. What effects does that have?

Effect: With the firm’s higher transportations costs, the aggregate supply shifts to the left.

Fluctuations in Aggregate Supply and Demand


The new equilibrium gives us an increase in price level, and we see that real GDP < potential GDP. This is a case of stagflation, where the economy is at a recession and there is inflation.

A case like this has happened to the US in 1970-1980s, but it is very rare.

Increase in Aggregate Supply

Suppose aggregate supply increases from a temporary decrease in the prices in oil. What effects does that have?

Effect: With the firm’s lower transportation costs, the aggregate supply shifts to the right.

Fluctuations in Aggregate Supply and Demand


The new equilibrium gives us a decrease in price level, and we see that real GDP > potential GDP. This is a case where the economy is at an expansion and there is deflation.

Once again, this does happen, but it is extremely rare.