ECON 1010 Chapter Notes -Business Cycle, Fiscal Policy, Monetarism
Econ notes number 2
Aggregate supply and aggregate demand.
AS-AD model is a model of an imaginary market for the total of all the final goods and services that make
up real GDP.
Quantity supplied and supply: the total quantity of goods and services, valued in constant base year
dollars, that firms plan to produce during given period.- depends on the quantity of labour employed,
quantity of physical and human capital, and the state of technology.
*the labour market can be in any one of three states: at full employment, above full employment or
below full employment.
Aggregated supply: the relationship between the quantity of real GDP supplied and the price level. It is
different in the long run and short run
Long run aggregated supply: the relationship between the quantity of real GDP supplied and the price
level when the money wage rate changes in step with the price level to achieve full employment.
Short run aggregated supply: the relationship between the quantity of real GDP supplied and the price
level when money wage rate, the price of other resources, and potential GDP remain constant.
Changes in Aggregated Supply
Changes in potential GDP: when GDP changes, aggregated supply changes. Potential GDP increases
because of three reasons: 1. An increase in the full employment quantity of labour
2. increase in the quantity of capital
3. advance in technology
Changes in the money wage rate and other factor prices
When the money price of something changes short run aggregated supply changes but not long run
The quantity of real GDP demanded (y) is the sum of real consumption expenditure (c ), investment (i),
goverments expenditures (G) and exports (X) minus imports (m)
The aggregated demand curve: described by an aggregated demand schedual and aggregate demand
curve. Why does it slop downward? For 2 reasons
1. Wealth effects: real wealth is t he amount of money in the banks, bonds, stocks, and other
assets people own. People have to save for something wich decreases consumption is a
decrease in aggregated demand.
2. Substitution effect: involves substituting goods in the future for goods in the present and is
called an intertemporal substitution effect- over time. Saving increases future consumption.
Changes in aggregated demand
3 main factors
1. Expectations: expect in future income increases the amount of consumption goods
2. Fiscal policy and monetary policy: fiscal policy: the governments attempt to influence the
economy by setting and changing taxes, making transfer payments, and purchasing goods and
Monetary policy: consists of changes in the interest rate and in the quantity of money in the
3. The world economy: two main influences that the world economy has on aggregated demand
are the exchange rate and foreign income.
Short run macroeconomic equilibrium: occurs when the quantity of real GDP demanded equals the
quantity of real GDP supplied.
Long run macroeconomics equilibrium: occurs when real GDP equals potential GDP –equivalently
when the economy is on its LAS curve
Macroecon school on thought
The classic view: believes that the economy is self-regulating and always at full employment. – New
classic view: business cycle fluctuations are the efficient responses of a well-functioning market
economy that is bombarded by shocks that arise from the uneven pace of technological change.
Classical policy: emphasizes the potential for taxes to stunt incentives and create inefficiency. By
minimizing the incentives and effects if taxes, employment, investment, etc at their efficient levels
and the economy expands at an appropriate and rapid place.
Keynesian view: left alone the economy would rarely operate at full employments and that to
achieve and maintain full employment active help from fiscal policy and monitory policy is required.
The monetarist view: the economy is self-regulating and that it will normally operate at full
employment, provided that monetary policy is not erratic and that the pace of money growth is kept