Economics 020

Lecture 11
29 September, 1997
 Aggregate Demand and
Aggregate Supply

 TheBig Picture
 Aggregate Demand

About the Midterm

 The Big Picture
 Macroeconomics is a large and
controversial subject
 It is interlaced with political ideological
disputes
 It is a field in which charlatans as well as
serious thinkers have much to say
 I want to give you a map that will guide you
through the terrain of macroeconomics
 The Big Picture
 You’ve
already met the questions that
macroeconomics seeks to answer:
 What causes unemployment?

What makes our economy grow?
 Why does the economy fluctuate in a business
cycle?
 What causes inflation?

What causes deficits across the sectors of the
economy?
 The Big Picture
 You’ve
also learned how we measure two
key macroeconomic variables:
 Real GDP, and
 The price level
 Your next big task is to study a model -- the
aggregate demand-aggregate supply
model -- that explains the growth and
fluctuations of real GDP as well as trends
and fluctuations in the price level
 The Big Picture
 The aggregate demand-aggregate supply
(AD-AS) model is analogous to the demand
and supply model of Chapter 4, but it differs
in some crucial ways that you’ll soon
understand
 Studying macroeconomics is like doing a big
jigsaw puzzle
 The AD-AS model is like the outline of the
puzzle
 The Big Picture
 Just as the edge pieces of a jigsaw puzzle
outline the picture, so the AD-AS model
outlines a picture of the economy
 But we must then fill in the detail
 We first fill in the detail of aggregate demand,
and then of aggregate supply
 When we’ve built the entire picture, we return to
the issues of unemployment, economic growth,
and inflation and study them in richer detail
 Aggregate Demand
 The purpose of the AD-AS model is to
enable us to understand and predict
changes in real GDP and the price
level.
 We begin by studying aggregate
demand
 Aggregate Demand
 The quantity of real GDP demanded
is the total amount of final goods and
services produced in Canada that
people, businesses, governments, and
foreigners plan to buy in a given period
of time and at a given price level
 Aggregate Demand
 The quantity of real GDP demanded
is
Y=C+I+G+X-M
 What Determines Buying
Plans?
 Totalspending plans depend on many
factors, but some of the main ones are:
 The price level
 Expectations
 Fiscal and monetary policy

The world economy
 What Determines Buying
Plans?
 We focus first on the relationship
between the quantity of real GDP
demanded and the price level, holding
all other influences constant
The Aggregate Demand Curve

 The relationship between the quantity of

real GDP demanded and the price level
is called aggregate demand
 Aggregate demand is described by an
aggregate demand schedule and an
aggregate demand curve
 Aggregate Demand

P Y
a 110 700
b 120 650
c 130 600
d 140 550
e 150 500
Why does the AD curve slope
downward?
 The ADcurve slopes downward for two
reasons:

Wealth effect
 Substitution effects
 Wealth Effect
 Other things remaining the same, the
higher the price level, the less wealthy
people are
 Money and other assets fixed in dollars
buys less
 Because money and other assets buy
less, the quantity of real GDP demanded
decreases as the price level rises (other
things remaining the same)
 Substitution Effects
 When today’s Canadian price level
changes, other things remaining the
same, the expected future price level
does not change and the price level in
the rest of the world does not change
 So people substitute between today
and tomorrow and between domestic
goods and services and foreign goods
and services
 Changes in Aggregate
Demand
 A change in any influence on spending
plans other than the price level changes
aggregate demand
 These other influences are:
 Expectations
 Fiscal and monetary policy
 The world economy
 Changes in Expectations

 Expectations about three factors have a

big influence on spending plans and
affect aggregate demand
 They are:
 Expectations about jobs and incomes
 Expectations about inflation
 Expectations about profits
 Changes in Policy

 Fiscal policy is the government’s

attempt to influence the economy by
setting and changing:
 taxes
 transfer payments
 expenditures on goods and services
 Changes in Policy

 Monetarypolicy is the Bank of

Canada’s attempt to influence the
economy by setting and changing:
 interest rates
 the exchange rate
 the quantity of money
 Changes in the World
Economy
 Theworld economy influences the
domestic economy through three
channels:
 Foreign prices (rest of world price level)
 The exchange rate
 Foreign income (rest of world real GDP)
 Changes in Aggregate
Demand
 A change in any
of the
influences
we’ve just
studied
changes
aggregate
demand and
shifts the AD
curve
 About the Midterm
Midterm exam, 8:30 AM, Saturday October 4
Rooms
A to Buckle SSC 3028
Butala to Fong SSC 2036
Ford to Jay SSC 2032
Jin to Martinek SSC 2028
Marwaha to Reuben SSC 2024
Ritter to Stark SSC 2020
Steadmann to Z SSC 2110
 About the Midterm
Regular makeup exam:
5:00 PM, Thursday October 2

Room SSC 2028

Religious holiday makeup exam:

5:00 PM, Tuesday October 7

Room SSC 2028

 Next

Review for Mid-term #1

Chapters 1, 3, 4, 22, 23 and 24
(part)