Overview

This topic explores how aggregate demand and aggregate supply interact to determine national output (GDP) and the price level. Understanding this equilibrium is key to analyzing inflation, unemployment, and economic fluctuations. Economists use this model to examine both short-run shocks and long-run trends.

Key Themes and Concepts

• Aggregate Demand (AD): Total spending in the economy at different price levels. Includes consumption, investment, government spending, and net exports.
• Determinants of AD: Changes in consumer confidence, taxes, investment expectations, fiscal/monetary policy, and global demand.
• Multiplier Effect: An initial change in spending leads to a larger overall impact on national income due to successive rounds of consumption.
• Crowding-Out Effect: Government spending may raise interest rates and reduce private investment, dampening expansionary fiscal policy.
• Aggregate Supply (AS):
  • Short-run AS: Upward sloping due to sticky wages and prices.
  • Long-run AS: Vertical at full employment output — reflects potential GDP.
  • Shifts: Influenced by productivity, resource availability, and policy changes.
• Macroeconomic Equilibrium:
  • Short-run: Where AD intersects short-run AS — determines output and price level.
  • Long-run: When output equals full employment; inflationary/recessionary gaps may exist if not at equilibrium.
• Business Cycle: Fluctuations in real GDP over time — includes expansion, peak, contraction, and trough.

Quick Tip

Aggregate demand and supply form the core of macroeconomic analysis. Use them to explain how economies respond to shocks and policy. Look for the gap between actual and potential output — that’s where intervention is most debated.