ECN Chapter 14 Aggregate Demand and Aggregate Supply
Three Key Facts About Economic Fluctuations
• Economic fluctuations are irregular and unpredictable
• Most macroeconomic quantities fluctuate together
• As output falls, unemployment rises
The model of Aggregate Demand and Aggregate Supply
• The model of aggregate demand and aggregate supply: The model that
economists use to explain short run fluctuations in economic activity around its
long run trend.
• Aggregate demand curve: A curve that shows the quantity of goods and services
that households, firms and the government want to buy at each price level.
• Aggregate supply curve: A curve that shows that quantity of goods and services
that firms choose to produce and sell at each price level.
The Aggregate Demand Curve
Why the Aggregate Demand Curve Slope Downwards
• A fall in the level of prices raises the quantity of goods and services demanded
which causes the demand curve to slope downwards.
• Three components contribute to the reason why aggregate demand curve slopes
The level of price and consumption: The Wealth Effect
When price level falls, consumers are wealthier, which stimulates the
demand for consumption goods
The interest rate effect: When prices fall, interest rate falls, which stimulates
the demand for investment goods
Net exports: The real exchange rate effect: When prices fall, the exchange
rate depreciates, and Canadian goods become more attractive to consumers in
Canada as well as in other countries which stimulates the demand for net
Why Might the Aggregate Demand Curve Shift?
1. Shifts arise from changes in consumption: An even that makes consumers
spend more at any given price level (tax cut, a stock market boom) shifts the
aggregate demand curve to the right. An event that makes consumers spend less at
any given price level (a tax hike, a stock market decline) shifts aggregate demand
curve to the left
2. Shifts arise from changes in investment: An event that makes firms invest m