Chapter 10: Aggregate Demand and Aggregate Supply

The relationship between price level and GDP demand is inverse/negative

• - Price level rises
• - Quantity of GDP demanded decreases

• - Price level falls
• - Quantity of GDP demanded increases

Inverse relationship between price level and real value (purchasing power)

A higher price level reduces the purchasing power of the public's savings; the value of assets diminishes

Higher price level = less consumption spending

Direct relationship between price level and demand for money

A higher price level increases the demand for money

Canadian price level rises ---> Foreigners buy fewer Canadian goods ---> Canadians buy more foreign goods ---> Canadian exports fall & Canadian imports rise

• Increase in Aggregate Demand:
• Amount of goods and services demanded is higher

• Decrease in Aggregate Demand:
• Amount of goods and services demanded is lower

Prices are fixed but output can vary

Both input and output prices can vary

Inflationary Gap:

The amount by which equilibrium GDP exceeds potential GDP

Recessionary Gap:

The amount by which equilibrium GDP falls short of potential GDP

• Increase in Aggregate Demand causes INFLATION
• and POSITIVE GDP GAPS (actual GDP exceeds potential GDP)

- Increase in Aggregate Demand increases both GDP and Price Level

• - Increase in Aggregate Demand from AD1 to AD 2
• - Inflation from P1 to P2
• - Output increases from GDP f to GDP 1
• 

- Causes Recession, Negative GDP Gaps and Cyclical Unemployment

If Price level is Downwardly Inflexible:

• - Decline of aggregate demand from AD 1 to AD 2 moves economy from a to b, and
• - reduces GDP from GDPf to GDP1

If price level is Flexible Downward,

- Decline in Aggregate Demand moves economy from a to c (instead of a to b)

Causes COST-PUSH Inflation

• - Aggregate supply shifts from AS1 to AS2
• - Economy moves from A to B
• - Price Level rises from P1 to P2
• - Real output declindes from GDPf to GDP2
• 

• Causes - full employment
• - economic growth
• - price stability