Output and prices in the short run
The demand Side of the Economy
Exogenous Changes in the Price Level
The curve shifts in response to a change in the price level.
Change in price level affects desired consumption expenditure and desired net exports
Changes in Consumption
A rise in the price level lowers the real value of money held by the private sector.
A fall in the price level raises the real value of money held by the private sector.
This change in wealth leads to changes in the amount of desired consumption expenditure
Changes in the price level change the wealth of bondholders and bond issuers, but because the changes
offset each other, there is no change in aggregate wealth.
Changes in Net Exports
When the domestic price level rises, Canadian goods become more expensive compared to foreign
Canadian consumers increase their consumption of foreign goods.
Foreign consumers decrease their consumption of Canadian goods.
Thus resulting in a downward shift of thefunction.
A rise in the domestic price level (with a constant exchange rate) shifts the net export function
downward, which causes a downward shift in the curve.
A fall in the domestic price level shifts the net export function upward and hecurve upward.
Changes in Equilibrium GDP
Rise in the price level equilibrium level of GDP falls.
Fall in the price level equilibrium level of GDP rises.
The Aggregate Demand Curve
Aggregate demand ( ) curve: A curve showing combinations of real GDP and the price level that make
desired aggregate expenditure equal to actual national income. For any given price level, the curve shows the level of real GDP for which desired aggregate
expenditure equals actual GDP.
The curve is not a Micro Demand Curve!
The curve is negatively sloped for 2 reasons:
1. A fall in the price level leads to a rise in private sector wealth, which increases desired
consumption and thus leads to an increase in equilibrium GDP.
2. A fall in the price level (for a given exchange rate) leads to a rise in net exports and thus leads to
an increase in equilibrium GDP.
Shifts in the curve
For a given price level, any event that leads to a change in equilibrium GDP will cause thecurve to
The event could be a change in government policy, such as the level of government purchases or
Any change –other than a change in the price level—that causes the curve to shift will also cause the
curve to shift.
Such a shift is called an aggregate demand shock.
For a given price level, an increase in autonomous aggregate expenditure shifts the curve upward
and the curve to the right. A fall in autonomous aggregate expenditure shifts the curve
downward and the curve to the left.
The Simple Multiplier and the curve
The simple multiplier measures the size of the change in equilibrium national income in response to a
change in autonomous expenditure when the price level is held constant.
The simple multiplier measures the horizontal shift in the curve in response to a change in
autonomous desired expenditure.
The Supply Side of the Economy
We’ll add an explanation for changes in the price level.
The Aggregate Supply Curve
Aggregate supply refers to the total output of goods and services that firms would like to produce.
Aggregate supply ( ) curve: A curve showing the relation between the price level and the quantity of
aggregate output supplied, for given technology and factor prices. The Positive Slope of the curve
COSTS AND OUTPUT
Unit cost: Cost per unit of output, equal to total cost divided by total output.
As output increases, less efficient standby plant may have to be used, and less efficient workers may
have to be hired, while existing workers may have to be paid overtime rates for addition work.
Unit costs will tend to rise as output rises, even when technology and input prices are constant.
PRICES AND OUTPUT
Some industries, especially those that produce raw materials, contain many individual firms.
Each firm is too small to influence the market price firms are said to be price takers.
If their unit cost