Chapter 5: Supply and Demand
Moving to Macroeconomic Aggregates
Aggregate demand (AD) = is the relationship between the quantity of domestic
product that is being demanded and the overall price level (cost of living)
Aggregate supply (AS) = is the relationship between the quantity of domestic
product that is being supplied and the overall price level
The overall price level can be thought as the cost of living
Major concerns of macroeconomics
Inflation: A sustained increase in the general price level. AD Þ price level
Unemployment: ˉAD Þ unemployment
Growth: GDP = GROWTH AND AD and/or AS Þ GROWTH
[Financial Stability? Equality of Opportunity?Environmental Sustainability?]
Gross Domestic Product
o Money as the Measuring Rod: Real vs. Nominal GDP
o GDP = sum of the money values of all final goods and services produced in
the domestic economy and sold on organized markets within the year
o Nominal GDP (GDP in current dollars) = values each good and service at the
price at which it was actually sold during the year.
Drawback of Nominal GDP: it changes when prices change even if there is no change in
Solution: calculate real GDP or GDP in constant dollars.
Real GDP is calculated by valuing outputs of different years at common prices. Therefore, real GDP is a far better measure than nominal GDP of changes in total
o A recession is when real GDP is declining.
o A convention is that a recession occurs when real GDP declines for at least two
consecutive quarters (six months). But this is just a convention.
What gets counted in GDP?
Only goods and services produced within the year
Only final goods and services (intermediate goods, purchased for use in producing
another good are excluded)
Only production within the geographic boundaries of Canada
The Economy on a Roller Coaster
Growth, but with Fluctuations:
Canada has seen significant fluctuations in economic growth, unemployment, and
Before WWII, the business cycle was particularly strong, the worst episode being
the Great Depression of the 1930s.
The extent to which greater macro stability is due to a larger role for the public
sector is debated
The Great Depression
A worldwide event most severe decline in economic activity
Caused a muchneeded revolution in economic thinking
Until the 1930s, the prevailing economic theory held that a capitalist economy
could cure recessions or inflations by itself
The Great Depression led John Maynard Keynes, one of the world’s most
renowned economists, to write The General Theory of Employment, Interest, and
Money (1936). Before that Keynes was known for his book The Economic Consequences of the
Peace (1919), his huge Treatise on Money (1930), and his involvement in politics.
He was also part of the Bloomsbury group, a group of intellectuals, artists,
writers, that introduced Sigmund Freud to England, and one of which was
Keynes believed that:
The economy did not naturally gravitate toward smooth growth and high levels of
A pessimistic outlook could lead business firms and consumers to curtail their
The economy could then be condemned to years of stagnation
In terms of the ADAS framework, Keynes suggested that there were times when
the AD curve shifted inward by large amounts.