3.2 - Aggregate Demand and Aggregate Supply

LRAS Curve

A curve showing the relationship between real GDP produced and the price level when wages (and other resource prices) change to reflect changes in the price level, ceteris paribus. The LRAS curve is vertical at the full employment level of GDP, of potential GDP, indicating that in the long run the economy produces to potential GDP, which is independent of the Price Level.

Business Confidence

A measure of the degree of optimism among firms in an economy about the future performance of firms and the economy; it is measured on the basis of surveys of business managers. It is an important determinant of the investment component of aggregate demand.

Consumer Confidence

A measure of the degree of optimism of consumers about their future income and the future of the economy; it is measured on the basis of surveys of consumers. It is an important determinant of the consumption component of aggregate demand.

Inflationary Gap

A situation where real GDP is greater than potential GDP, and unemployment is lower than the natural rate of unemployment; it arises when the AD curve intersects the SRAS curve at a higher level of real GDP than potential GDP.

Recessionary/Deflationary Gap

A situation where real GDP is less than potential GDP, and unemployment is greater than the natural rate of unemployment; it arises when the AD curve intersects the SRAS curve at a lower level of real GDP than potential GDP

Monetarist (New Classical) Model

Actually includes two different models of the macro-economy (the monetarist and the new classical); both are based on the following principles: the importance of the price mechanism in cooperating economic activities, the concept of competitive market equilibrium, and thinking about the economy as a harmonious system that automatically tends towards full employment.

Keynesian AS Curve

An aggregate supply curve that has a flat (horizontal) section, an upward sloping section and a vertical section.

Market-Based Supply-Side Policy (also called Supply-Side Regulatory Policies)

Concerned with raising productive capacity, but does so by making improvements in the institutional framework.

Determinants of Aggregate Demand

Factors that cause shifts in the aggregate demand curve; include factors that influence consumption spending (C), investment spending (I), government spending (G), and net exports (Xn).

Full Employment Level of Output

In the context of the AD-AS model, refers to the natural rate of unemployment, or unemployment that prevails when the economy is producing potential output, or real GDP, determined by the position of the LRAS curve (when the economy is in long-run equilibrium). In this context, 'full employment' refers to employment of labour resources.

SRAS

In the new classical model, it is the level of output (real GDP) determined by the intersection of the aggregate demand and short run aggregate supply curves. In the Keynesian model, it is the level of output determined by the intersection of the aggregate demand and Keynesian aggregate supply curves. In both models, equilibrium may occur where there is: 1) a recessionary (deflationary) gap, 2) an inflationary gap or 3) full employment output.

LRAS

Long-Run Aggregate Supply (which represents the classical point of view); output must be lower than the full employment level, because output above the full employment level is unsustainable as some unemployment is necessary for people to change jobs and for firms to retool.

Keynesian Demand Management

Manipulation of government taxation, spending and interest rates to spur spending and investment. It uses fiscal and monetary policy to reduce the volatility of the business cycle.

Spare Capacity

Refers to physical capital that firms have available but do not use; arises in a recession when there is unemployment of resources.

Personal Income Taxes

Taxes paid by households or individuals in households on all forms of income, including wages, rental income, interest income and dividends (income from ownership of shares in a company); is the most important source of government tax revenues in many countries (especially economically more developed countries).

AD Curve

The curve that shows the relationship between total quantity of goods and services that all buyers in an economy want to buy over a particular time period (aggregate demand), measured on the horizontal axis, plotted against the price level, measured on the vertical axis.

Corporate Indebtedness

The degree to which corporations have debts.

Household Indebtedness

The degree to which households have debts.

Interventionist Supply-Side Policy

The government invests in improved healthcare and education (to improve quality of labor force) and in infrastructure to ease transport or communications bottlenecks which may have been limiting productivity.

Disposable Income

The income of consumers that is left over after the payment of income taxes.

Equilibrium Level of Output

The level of output (real GDP) where the aggregate demand curve intersects the aggregate supply curve (also known as the 'equilibrium level of income'). Note the distinction between short-run equilibrium level of output and long-run equilibrium level of output.

Keynesian Multiplier

The ratio of real GDP divided by a change in any of the components of aggregate spending (consumption, investments, net-exports). The value of this ratio is usually greater than one because of a multiplied effect of an initial change in components of aggregate supply on the final value of real output.

Money Illusion

The tendency of people to think of currency in nominal rather than real terms.

Aggregate Supply

The total quantity of goods and services produced in an economy over a particular time period, at different price levels, ceteris paribus.

Aggregate Demand

The total quantity of goods and services that all buyers in an economy (consumers, firms, the government and foreigners) want to buy over a particular time period, at different possible price levels, ceteris paribus.