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Lecture 11

ECON 1BB3 Lecture Notes - Lecture 11: Aggregate Demand, Aggregate Supply, Interest Rate

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Bridget O' Shaughnessy

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How do aggregate demand and aggregate supply differ from demand and supply?
Aggregate demand curve
- AD: Y=C+I+G+NX
-The AD curve has a negative slope for 3 reasons:
1. Wealth effect
2. Interest rate effect
3. Real exchange rate effect
Wealth Effect
-Prices decrease
oPeople feel wealthier
oConsumption increases
oTherefore GDP increases (if C goes up in the equation, Y will too)
oCauses a movement along the curve, not a shift
Interest Rate Effect
-2 assets
oMoney (no interest)
oBonds (interest)
-Opportunity cost of holding money is interest rate
-Prices decrease
oPeople buy same quantity of goods as before, costs less
oNeed less money
oMoney demanded shifts to the left (less money demanded)
oInterest rate decreases
oInvestment increases
oGDP increases
Real Exchange Rate Effect
-Prices decrease
oeP/p* decreases because P decreases
oCanadian goods become less expensive
oImports decrease
oExports increase
oGDP increases (NX goes up therefore Y will too )
Shift factors for the AD curve
-Anything other than P that affects C, I, G or NX will cause the AD curve to shift
Aggregate Supply
- LRAS (long run aggregate supply): Y=A*F(K, L, H, N)
oA, K, L, H, N do not depend on price (recall the classical dichotomy – the long run separation of
real and nominal variables)
-LRAS is a vertical slope
oAny change in A, K, L, H or N will cause the LRAS curve to shift
Short Run Aggregate Supply – SRAS
-The slope is positive for 3 reasons
1. Sticky wage theory
Nominal wages are sticky
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