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Macroeconomics 1 – The domestic economy

Aggregate supply and demand

4.1 Aggregate Demand (AD)

 AD = total demand for goods and services in the economy

 AD = C + I + G + (X - M)

 AD is inversely related to prices since a price fall would raise everyone’s real
(purchasing power) wealth and thus tend to raise spending.

 AD may shift if any one component (e.g. investment or exports) changes
through the multiplier effect.

 Thus the AD curve slopes down from left to right but may shift.

4.2 Aggregate Supply (AS)

 AS = the willingness and ability of producers in an economy to produce and
offer for sale, goods and services.

 The AS curve is positively related to the price level since, other things being
equal, a rise in the price level will make sales more profitable and thus
encourage businesses to expand output;

 AS is limited by the availability of resources (labour, capital, etc.) so that at full
employment, output cannot be increased any further;

 AS can only shift in the long run as the result of a change in the costs of
production or in the availability of factors of production.

 Thus the AS curve slopes upward from left to right and does not shift in the
short run.

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