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Мулаа моххамед бесем 429

aygregate Demand and Aggregate Supply
1. What is the meaning of each of the following terms:
• Aggregate demand
Aggregate demand curve
Aggregate quantity demanded
• Aggregate quantity supplied
Aggregate supply
Aggregate supply curv
, Change in aggregate deman Change in aggregate suppl Macroeconomic equilibriu
Distinguish an aggregate demand curve from a market demand curve and explain why a
ggregate demand curve is downward sloping
• Distinguish an aggregate supply curve from a market supply curve and explain the shape o in aggregate supply curve prevailing in the short rut
• Discuss the concept of macroeconomic equilibrium and identify the point of macroeconomic equilibrium on an aggregate demand-aggregate supply graph.
Show how changes in aggregate demand can affect macroeconomic equilibrium.
• Show how changes in aggregate supply can affect macroeconomic equilibrium.

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Task 1: What is the meaning of each of the following terms:

• Aggregate demand (AD): Total demand for all goods and services in an economy at a given overall price level and time.
• Aggregate demand curve (AD curve): Graph showing the inverse relationship between the overall price level and the total quantity of real GDP demanded.
• Aggregate quantity demanded (AQD): The total real GDP that all sectors (households, firms, government, foreign) are willing to buy at a specific price level.
• Aggregate quantity supplied (AQS): The total real GDP that firms are willing to produce and sell at a specific price level.
• Aggregate supply (AS): Total supply of all goods and services that firms in an economy are willing to produce at a given overall price level and time.
• Aggregate supply curve (AS curve): Graph showing the relationship between the overall price level and the total quantity of real GDP supplied.
• Change in aggregate demand: A shift of the entire AD curve due to non-price factors (e.g., consumption, investment, government spending, net exports).
• Change in aggregate supply: A shift of the entire AS curve due to non-price factors (e.g., resource prices, technology, productivity).
• Macroeconomic equilibrium: The point where the aggregate demand curve intersects the aggregate supply curve, determining the economy's equilibrium price level and real GDP.

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Task 2: Distinguish and Explain

• Distinguish AD curve from market demand curve & why AD is downward sloping.
• Market Demand: For one good, reflecting substitution/income effects.
• Aggregate Demand: For all goods (GDP).
• Downward Sloping Reason:
1. Wealth Effect: Lower prices increase real value of wealth, boosting consumption.
2. Interest-Rate Effect: Lower prices reduce demand for money, lowering interest rates, boosting investment/consumption.
3. Exchange-Rate Effect: Lower prices make domestic goods cheaper, boosting net exports.

• Distinguish AS curve from market supply curve & short-run AS shape.
• Market Supply: For one good, based on firm's profit motive.
• Aggregate Supply: For all goods (GDP).
• Short-Run AS (SRAS) Shape: Upward Sloping.
* Reasons: "Sticky" wages/prices (nominal wages fixed in short run, some prices slow to adjust) mean higher output prices increase firms' profits, incentivizing more production. Also, misperceptions theory.

• Macroeconomic equilibrium concept & identification on graph.
• Concept: Occurs when total quantity demanded (AD) equals total quantity supplied (AS) at a specific overall price level and real GDP. Represents a balanced state for the economy.
• Identification: The intersection point of the AD curve and the SRAS curve (and LRAS for long-run equilibrium).

• How changes in aggregate demand affect macroeconomic equilibrium.
• Increase in AD (Right shift): In short run, increases both real GDP and price level. In long run (if at full employment initially), it leads to higher price level but real GDP returns to full employment level.
• Decrease in AD (Left shift): In short run, decreases both real GDP and price level. In long run (if at full employment initially), it leads to lower price level but real GDP returns to full employment level.

• How changes in aggregate supply affect macroeconomic equilibrium.
• Increase in AS (Right shift): Increases real GDP and decreases price level (good for economy).
• Decrease in AS (Left shift): Decreases real GDP and increases price level (stagflation – bad for economy).

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1. Aggregate Demand Curve vs. Market Demand Curve

Aspect Market Demand Curve Aggregate Demand Curve
What it represents Demand for a single good or service (e.g., cars, apples) in a specific market. Demand for all final goods and services in the entire economy.
Price on vertical axis Price of that specific good (e.g., price of apples in $/kg). Overall price level (e.g., GDP deflator or CPI) for the economy.
Quantity on horizontal axis Quantity of that specific good demanded. Real GDP (total output of the economy demanded).
Reason for slope Downward sloping due to substitution and income effects for that good. Downward sloping due to three economy-wide effects (see next section).
Shifts caused by Changes in price of related goods, consumer income (for that good), tastes, expectations for that good. Changes in C, I, G, NX components due to factors like interest rates, fiscal policy, expectations, foreign income.

Key difference:
Market demand is microeconomic, looking at one market assuming other prices/income constant. Aggregate demand is macroeconomic, reflecting the entire economy’s spending at different general price levels.

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2. Why the Aggregate Demand Curve Slopes Downward

Three main effects explain the inverse relationship between price level and real GDP demanded:

1. Wealth Effect (Real Balances Effect)
· When the price level rises, the real value of money and other financial assets held by households falls.
· People feel poorer and reduce consumption spending (C↓).
2. Interest Rate Effect
· A higher price level increases the demand for money for transactions.
· With a fixed money supply, this pushes up interest rates.
· Higher interest rates discourage borrowing for investment and certain consumption (I↓, C↓).
3. International Trade Effect
· A higher domestic price level makes domestic goods more expensive relative to foreign goods.
· Exports fall, imports rise → net exports (NX↓).

Since AD = C + I + G + NX, a higher price level reduces C, I, and NX, decreasing total quantity of real GDP demanded.

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3. Aggregate Supply Curve vs. Market Supply Curve

Aspect Market Supply Curve Aggregate Supply Curve
What it represents Supply of a single good/service by firms in a specific market. Supply of all goods and services by all firms in the economy.
Price on vertical axis Price of that specific good. Overall price level.
Quantity on horizontal axis Quantity of that specific good supplied. Real GDP (total output supplied).
Typical shape Upward sloping (law of supply: higher price → higher quantity supplied for that good). Short-run AS: Upward sloping. Long-run AS: Vertical at potential GDP.
Reason for slope (short-run) Rising marginal cost of producing more of that good. Nominal wages/prices are sticky in short run, so higher price level increases profitability, encouraging more output.

Key difference:
Market supply depends on the price of that good and its production costs. Short-run aggregate supply depends on the general price level and nominal wage rigidity.

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4. Shape of the Short-Run Aggregate Supply (SRAS) Curve

The SRAS curve is upward sloping because of sticky wages and prices in the short run.

Reasons:

1. Sticky Wages: Labor contracts fix nominal wages for a period. If the price level rises, real wages fall (since nominal wage / price level = real wage).
→ Lower real wage means cheaper labor for firms → firms hire more workers → output increases.
2. Sticky Prices: Some firms have menu costs (cost of changing prices), so they may increase output instead of immediately raising prices when demand rises.
3. Misperceptions Theory: Firms may confuse a general price increase with increased demand for their specific product, so they produce more.

Thus, higher price level → higher profitability → increased output in the short run.

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5. Macroeconomic Equilibrium & Its Point on Graph

· Macroeconomic equilibrium occurs where aggregate quantity demanded = aggregate quantity supplied.
· On an AD-AS diagram, this is at the intersection of the AD and AS curves.
· This point determines:
· Equilibrium price level (on vertical axis)
· Equilibrium real GDP (on horizontal axis)

Graph point labeled E:

```
Price Level
↑
| SRAS
| \
| \
| \
| \
| \
| \
| \
| \ AD
| \ /
| \/
| E
| / \
| / \
+---------------------→ Real GDP
```

E = equilibrium.

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6. Effect of Changes in Aggregate Demand on Equilibrium

Increase in AD (rightward shift, e.g., due to tax cuts, increased government spending, higher consumer confidence):

· New AD curve intersects SRAS at a point to the right and higher than the original equilibrium.
· Results:
→ Higher real GDP (economic expansion)
→ Higher price level (inflation)

Decrease in AD (leftward shift, e.g., due to higher interest rates, pessimism, reduced government spending):

· New AD curve intersects SRAS at a point to the left and lower.
· Results:
→ Lower real GDP (recession, higher unemployment)
→ Lower price level (deflationary pressure)

This is the basis for demand-side stabilization policy (fiscal and monetary policy).

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7. Effect of Changes in Aggregate Supply on Equilibrium

Increase in AS (rightward shift, e.g., due to lower input prices, technological improvement, beneficial supply-side policies):

· New SRAS intersects AD at a point to the right and lower.
· Results:
→ Higher real GDP (economic growth)
→ Lower price level (reduced inflation)
→ “Win-win” scenario (if AD is stable).

Decrease in AS (leftward shift, e.g., due to oil price shock, natural disaster, increased regulations raising costs):

· New SRAS intersects AD at a point to the left and higher.
· Results:
→ Lower real GDP (stagflation – recession)
→ Higher price level (inflation)
→ Problematic for policymakers (trade-off between inflation and unemployment worsens).

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Summary Table: Effects of Shifts

Shift Real GDP Price Level Typical Cause
AD increases ↑ ↑ Expansionary policy, confidence rise
AD decreases ↓ ↓ Contractionary policy, confidence fall
AS increases ↑ ↓ Productivity gain, input price fall
AS decreases ↓ ↑ Supply shock, cost increase

This AD-AS framework is fundamental for analyzing business cycles, inflation, unemployment, and policy impacts in macroeconomics.

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Мулаа мохамед бесем 429

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