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ECON102: Principles of Macroeconomics

Unit 4: Aggregate Demand and Supply   *Since macroeconomics studies the whole economy, it looks at the main forces affecting growth, inflation, and unemployment by aggregating, or totaling, output (via the GDP) and prices (via a price index).  Unlike microeconomics, which studies the demand and supply of individual goods and services, macroeconomics considers demand and supply for all goods and services in a national economy.

In macroeconomics, aggregate demand is the total amount of goods and services people want to buy – in other words, it measures what people wish to purchase rather than what is actually produced.  The aggregate demand is the sum of consumption, investment, government expenses, and net exports.  Aggregate supply, on the other hand, is the total output an economy produces at a given price level.  As you learned in microeconomics, firms achieve equilibrium when they produce the quantity of goods and services consumers want to buy, that is, when aggregate supply equals aggregate demand.  This unit examines shifts in aggregate supply and aggregate demand and their short-term and long-term effects for the whole economy.*

Unit 4 Time Advisory
This unit should take approximately 12.25 hours to complete.

☐    Subunit 4.1: 4.75 hours

☐    Subunit 4.2: 4.5 hours

☐    Assessments: 3 hours

Unit4 Learning Outcomes
Upon successful completion of this unit, the student will be able to: - Define aggregate demand, graphically represent a hypothetical aggregate demand curve, and identify the reasons for the negative slope of the demand curve. - Distinguish between a change in the aggregate quantity of goods and services demanded and a change in aggregate demand. - Define “multiplier” and explain how to calculate it. - Graphically represent a hypothetical long-run aggregate supply curve and explain the underlying connotations for natural levels of employment and output at various price levels, given changes in aggregate demand. - Graphically represent a hypothetical short-run aggregate supply curve, explain why it slopes upward, and explain why it may shift. - Discuss various explanations for wage and price stickiness. - Explain and illustrate what is meant by equilibrium in the short run and relate the equilibrium to potential output. - Explain and graphically represent the consumption function and the saving function, explain the slopes of their respective curves, and explain their relationship to each other. - Compare the current income hypothesis with the permanent income hypothesis. - Discuss two factors that can cause the consumption function to shift upward or downward.

4.1 Aggregate Demand and Aggregate Supply   - Reading: State University of New York at Oswego: Professor John Kane’s Lecture notes on Principles of Macroeconomics: “Chapter 9: Aggregate Demand and Supply” Link: State University of New York at Oswego: Professor John Kane’s Lecture Notes on Principles of Macroeconomics: “Chapter 9: Aggregate Demand and Supply” (HTML)

 Instructions: These are introductory notes about aggregate demand
and supply.  Read this entire set of lecture notes for an overview
of the demand and supply model in the macroeconomic context.  For
Aggregate Demand (AD), please pay special attention to the
components that constitute aggregate demand and the factors that
affect each of these components resulting in shifts of the AD
curve.  These lecture notes also explain why the AD curve is
negatively-sloped.  (For those who have studied Microeconomics, note
that the reason for the negative slope of the AD curve is different
than what it was for the individual/market demand curve.)  For
Aggregate Supply (AS), please be aware of the distinction between
the Short-Run AS curve and the Long-Run AS curve and the factors
that lead to shifts or changes in the two curves respectively. 
Finally, look at how the AD and the AS interact to reach
equilibrium.  This material also covers sub-subunits 4.1.1-4.1.6.  
    
 Terms of Use: Please respect the copyright and terms of use
displayed on the webpage above.
  • Reading: Prentice Hall Companion Website: Karl E. Case and Ray C. Fair’s Principles of Macroeconomics “Chapter 13: Aggregate Demand, Aggregate Supply, and Monetary and Fiscal Policy” Link: Prentice Hall Companion Website: Karl E. Case and Ray C. Fair’s Principles of Macroeconomics: “Chapter 13: Aggregate Demand, Aggregate Supply, and Monetary and Fiscal Policy” (HTML)
     
    Instructions: Read the entire chapter and work with the interactive active graphs to develop an understanding of the concepts covered in this chapter.  
     
    Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

  • Web Media: YouTube: econsteve12’s “AS AD Aggregate Supply and Aggregate Demand” Link: YouTube: econsteve12’s “AS AD Aggregate Supply and Aggregate Demand” (YouTube)
     
    Instructions: Watch this video, which discusses aggregate supply and aggregate demand.

    Watching this video should take approximately 6 minutes.
     
    Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

  • Reading: Principles of Macroeconomics: “Chapter 7: Aggregate Demand and Aggregate Supply”

    Link: Principles of Macroeconomics: “Chapter 7: Aggregate Demand and Aggregate Supply” (PDF)

    Instructions: This reading will provide you with the details and examples needed to master aggregate demand and aggregate supply.  Read the entire chapter and then answer the questions in the “Try It” box at the end of each section before reviewing the correct answers.
     
    Terms of Use: This text was adapted by The Saylor Foundation under a Creative Commons Attribution-NonCommercial-Share-Alike 3.0 License without attribution as requested by the work’s original creator or licensee.

  • Reading: Bureau of Economic Analysis: “Table 1.1.5: Gross Domestic Product” Link: Bureau of Economic Analysis: “Table 1.1.5: Gross Domestic Product” (PDF)
     
    Instructions: This table contains statistics on various components of the GDP from 2010 to 2012.  Observe how the United States has gone through growth and contraction at various points during this time period.  The data is correlated to the changes in the United States’ aggregate demand.
     
    Terms of Use: This work is in the Public Domain.

  • Assessment: Cengage Learning: William Boyes and Michael Melvin’s Economics: “Chapter 9: Macroeconomics Equilibrium: Aggregate Demand and Supply – Test 1 and Test 2”

    Link: Cengage Learning: Boyes/Melvin’s Economics: “Chapter 9: Macroeconomics Equilibrium: Aggregate Demand and Supply – Test 1 and Test 2” (Flash)

    Instructions: Click on the hyperlinks for Test 1 and Test 2 beneath Chapter 9 on the linked paged, and complete each assessment.  Once you have selected an answer choice, a note at the bottom of the screen will indicate whether your choice was correct or incorrect.  Please note that this material also covers subunits 4.1.1-4.1.6.

    Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

  • Web Media: Khan Academy’s “Aggregate Demand”

    Khan Academy’s “Aggregate Demand”(YouTube)

    Instructions: The above link will bring you to a video lecture about aggregate demand. 

    The video is approximately 14 minutes long.

    Terms of Use: This video is licensed under a Creative Commons Attribution-NonCommercial-ShareAlike 3.0 United States License.  It is attributed to the Khan Academy.

  • Reading: YouTube: ACDC Leadership’s “Inflationary and Recessionary Gaps: Fiscal and Monetary Policy Overview” Link: YouTube: ACDC Leadership’s “Inflationary and Recessionary Gaps: Fiscal and Monetary Policy Overview” (YouTube)

    Instructions: Watch this brief video.

    Watching this video should take approximately 4 minutes.

    Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

  • Reading: The Federal Reserve Board’s The Federal Reserve System: Purposes and Functions: “Chapter 2, Monetary Policy and the Economy” Link: The Federal Reserve Board’s The Federal Reserve System: Purposes and Functions: “Chapter 2, Monetary Policy and the Economy” (PDF)

    Instructions:  Click the link above, and then click on and download the PDF for Chapter 2.  Read this chapter for a brief overview of how monetary policy is conducted in the United States.

    Reading this chapter should take approximately 30 minutes.

    Terms of Use:  This material is in the public domain.

4.1.1 Components of Aggregate Expenditure (Consumption, Investment, Government Purchases, and Net Exports)   Note: The four components of the GDP (consumption, investment, government purchases, and net exports) contribute to the aggregate demand for goods and services.

4.1.2 Slope of the Aggregate Demand Curve   Note: The aggregate demand curve slopes downward due to the price level and consumption (the wealth effect), the price level and investment (the interest rate effect), and the price level and net exports (the exchange rate effect).  Economists refer to each of these effects as independent variables (or causes).  Economists refer to outcomes as the effects.  Consequently, cause and effect is the reason that the aggregate demand curve has a downward slope.

4.1.3 Shifts of the Aggregate Demand Curve   Note: There are numerous factors that affect the quantity of goods and services demanded at a given price level.  When a factor changes, the aggregate demand curve shifts left or right.

4.1.4 Aggregate Supply in the Short- and Long-Run   Note: The short-run aggregate supply curve slopes upward due to the lag between product prices and resource prices that makes it profitable for firms to increase output when the price level rises.  The long-run aggregate supply curve is vertical when a country is at full employment.  The long-run aggregate supply curve is vertical because in the long run resource prices adjust to changes at the price level, which leaves no incentive for firms to change their output.  In the long run, prices and wages have no effect on the aggregate supply curve.

4.1.5 Shifts in the Aggregate Supply Curve   Note: Price levels can cause changes or shifts in the aggregate supply curve.  Determinants (domestic prices, prices of imported resources, or market power in certain industries) also cause shifts in the aggregate supply curve (moving left or right).

4.1.6 Macroeconomic Equilibrium   Note: Macroeconomic equilibrium is determined when a country’s data indicates that its GDP is equal to its aggregate expenditures and when its savings is equal to its investments.

4.2 Income-Expenditure Model   - Reading: University of Washington: Professor Colin Danby’s Macroeconomics Teaching Notes: “Aggregate Demand”

Link: University of Washington: Professor Colin Danby’s
*Macroeconomics Teaching Notes*: [“Aggregate
Demand”](http://faculty.washington.edu/danby/notes/notes910.html) (HTML)  

 Instructions: This material will cover subunits 4.2.1-4.2.4.  It
covers macroeconomic theory and the Income-Expenditure model. 
Important concepts to master in this section are “planned” levels of
expenditure, marginal propensity to consume, marginal propensity to
save, the multiplier, and the equilibration process.  Please read
through section 1.10 (“The Multiplier”).  

 Terms of Use: Please respect the copyright and terms of use
displayed on the webpage above.
  • Reading: Principles of Macroeconomics: “Chapter 13: Consumption and the Aggregate Expenditures Model”

    Link: Principles of Macroeconomics: “Chapter 13: Consumption and the Aggregate Expenditures Model” (PDF)

    Instructions: This chapter will cover subunits 4.2.1 and 4.2.2 and will show you how the aggregate demand curve can be derived from the aggregate expenditures model.  Note that aggregate expenditures relate to the summation of “planned” levels of consumption, investment, government purchases, and net exports at a given price level.  Also notice how the slope of the aggregate expenditures curve relates to the multiplier.

    Terms of Use: This text was adapted by The Saylor Foundation under a Creative Commons Attribution-NonCommercial-Share-Alike 3.0 License without attribution as requested by the work’s original creator or licensee.

4.2.1 Planned Aggregate Expenditure   Note: Planned aggregate expenditure occurs when a country adds its consumption to its investments.

4.2.2 Adjustment to Equilibrium   Note: Adjustment to equilibrium occurs when a country’s consumption equals its investments and its savings equals its investments.  Consequently, the country has zero unplanned changes in inventory and its GDP equals its aggregate expenditure.

4.2.3 The Multiplier   - Web Media: YouTube: Living Economics’ Macroeconomic Lectures: “Spending Multiplier”

Link: YouTube: Living Economics’ *Macroeconomic Lectures*:
[“Spending
Multiplier”](http://livingeconomics.org/youtube.asp?docId=389) (YouTube)  

 Instructions: Watch this brief video, which discusses the spending
multiplier (also known as the expenditure multiplier).  

 Terms of Use: Please respect the copyright and terms of use
displayed on the webpage above.
  • Assessment: Econ100’s “Chapter 12: Expenditure Multipliers Quiz” Link: Econ100’s “Chapter 12: Expenditure Multipliers Quiz” (HTML)
     
    Instructions: Click on the “Quiz” tab on the left-hand menu, and then go to “Chapter 12” to take the quiz.
     
    Terms of Use: Please respect the copyright and terms of use displayed on the webpage above.

4.2.4 Saving-Investment Approach to Equilibrium GDP   - Assessment: International Excellence Business School: Javier Carrillo’s Multimedia Documentation: “Interactive Graph of the Aggregate Demand” and “Interactive Graph of the Aggregate Supply and Demand Model” (Flash) Link: International Excellence Business School: Javier Carrillo’s Multimedia Documentation: “Interactive Graph of the Aggregate Demand” and “Interactive Graph of the Aggregate Supply and Demand Model” (Flash)

 Instructions: Follow the instructions on the linked sites to use
these interactive modules.  

 After you have familiarized yourself with the graphs, proceed to
the exercises on the bottom right of the page.  Check your answers
and review the explanations for each answer provided.  

 Terms of Use: The materials above are released under a [Creative
Commons Attribution-NonCommercial-NoDerivatives License
3.0](http://creativecommons.org/licenses/by-nc-nd/3.0/).  You can
find the original International Excellence Business School version
of these
materials [here](http://openmultimedia.ie.edu/fichas/_en_econ_i.html).