Class Notes (1,000,000)
CA (620,000)
UTSC (30,000)
MGEA06H3 (100)
Iris Au (100)
Lecture 6

MGEA06H3 Lecture Notes - Lecture 6: Price Level, Aggregate Demand, Aggregate Supply


Department
Economics for Management Studies
Course Code
MGEA06H3
Professor
Iris Au
Lecture
6

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MGEA06 Week 6 © Iris Au 1
Chapter 12 Aggregate Demand and Aggregate Supply (Part 1)
Outline
Derive the aggregate demand curve from the income-expenditure model.
Derive the short-run & long-run aggregate supply curves.
Discuss the short-run equilibrium vs. the long-run equilibrium.
Introduce the concept of output gap.
Discuss the (natural) adjustment mechanism.

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MGEA06 Week 6 © Iris Au 2
Aggregate Demand (AD)
An economy’s aggregate demand shows the relationship between the
aggregate price level and the quantity of aggregate output demanded by all
sectors in the economy (households, firms, the government, and the foreign
sector).
Holding all else constant, there is an inverse relationship between the
aggregate price level (P) and the quantity of aggregate output demanded.
Why Is the Aggregate Demand Curve Downward Sloping?
The national income identity (Chapter 7):
GDP = Y = C + I + G + X IM
With the exception of G, most of the components of GDP are largely from
the private sectors.
To derive the AD curve, we need to understand how does a change in P
affect C, I, X, and IM.
An obvious but WRONG answer: If P , demand for goods and services .
In macroeconomics, we look at the demand for ALL goods and services.
If all prices, including prices of labour & capital, increase, then dollar
incomes also increase.
If both incomes and prices increase at the same rate, there is no change in
real income = Dollar income
Price there should be no change in aggregate
demand.

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MGEA06 Week 6 © Iris Au 3
A downward sloping AD curve can be explained by the wealth effect and the
interest rate effect.
The Wealth Effect
Holding all else constant, a rise in price lowers the real value of existing
assets real value of wealth .
When P , wealth (autonomous) C (Chapters 10 & 11) AD .
The Interest Rate Effect
Holding all else constant, interest rate rises when price increases because a
rise in price lowers the purchasing power of our (existing) money holdings.
To purchase the same amount of goods and services, we need to hold
more money than before.
To increase their money holdings, people will withdraw from their
savings or increase their borrowings interest rate . (Chapter 10)
When interest rate , cost of borrowing investment . (Chs 10 & 11)
When interest rate , current consumption become more expensive
consumption . (Chapter 10)
An open economy will also experience (net) capital inflows when interest
rate  domestic currency appreciates X & IM NX . (Ch 19)
In conclusion, C , I & NX when price AD .
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