1
Chapter 6
Aggregate Supply、
Aggregate Demand and
Price Adjustment
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90 91 92 93 94 95 96 97 98 99 00
Topics to be Discusses
? Aggregate Demand (AD) Function
? Aggregate Supply（ AS） Function
? AS-AD Model
? Price Changes and Determination of
Output
? Price Adjustment Process
? Aggregate Demand,the gross demand for
production and service under a given price
level,
? AD Function,the relationship between
aggregate and price level,or the quantitative
relations between general price level and
social equilibrium expenditure,
NXGICAD ????
6.1 AD Function
6.1 AD Function
?AD Curve
?From the angle
of aggregate
expenditure,
? Price is P0，
Aggregate
expenditure is AE0
? Price is P1，
Aggregate
expenditure is AE1
AE
E’0
Y Y0
AE0
AE1
Y0 Y
P
P0
Y1
Y1
AD
P1
E0
E1
O
E’1
O
? Why is the AD Curve downward sloping?
? Interest Effect,P?? Md? ? R? ? I? ? AE and Y ?
? Real Income Effect,P? ? Wealth ?? C and I ? ? AE
and Y?
? Taxation Effect,P ?? Wage ?? T ?? Yd? ? C and I ?
? AE and Y?
? Import-and-export,P? ? X ?,M? ? I ? ? AE and Y ?
6.1 AD Function
6.1 AD Function,Monetary Policies
and AD Curve
R
Y Y
R1
Y1
IS1
P LM1
Y1
AD1
P1
?Increase nominal money supply at the equilibrium point (R1,Y1)
LM2
1,
?LM Curve shifts down to LM2,and under the same price level
P1output increases to Y2
Y2
R2
Y2
2,2,
?AD Curve shifts to AD2
AD2
3,
R
Y Y
R1
Y1
IS1
P LM1
Y1
AD1
P1
?Increase government purchase at the equilibrium point (R1,Y1)G
IS2
1,
?IS Curve shifts to IS2,and under the same price level output
increases to Y2
Y2
R2
Y2
2,2,
?AD curve shifts to AD2
AD2
3,
6.1 AD Function,Fiscal policies
and AD curves
6.1 AD Function,IS-LM Curves and AD
Curves in Short or Long Term
? IS-LM,
? Short term (Keynesian),given P = P1,solve r
and Y。
? IS-LM for a given price level
? Long term (Classical),given Y = YLR solve r
and P。
? LRAS and AD curves
),(/
)()(
rYLPM
GrITYCY
?
????
6.2 AS Function
?Determinants of AS
?Human resources,including the quantity
and quality of labor
?Nature resources,including land,mine,
forests,ocean and anything that could be
used for production and services
?Capital stock,including factories,
equipments,highway etc,
?Technology,the transformation from inputs
to outputs
6.2 AS Function
?Aggregate Supply,gross supply of
productions and services in the whole
society at a given price level,which
depends on one country’s productive
factors and technology level,
?AS Function,the relationship between
aggregate supply and price level,or the
quantitative relationship between gross
supply in the whole society and the price
level,
6.2 AS Function
?Functions affecting AS
?Production function
?Labor demand and supply function
?Wage function
? Human resources,the quantity and quality of labor
0
N
Ls1
0
N
Ls2
0
N
Ls
Labor supply curve
Substitutive effect Income effect
6.2 AS Function
W
P
W
P
W
P
6.2 AS Function
?Classical or long-term AS curve
?Shape, a vertical line of the output with full
employment,
?Assumptions,
?Monetary wage has complete elasticity
?Ns>Nd ? W ? ; Ns<Nd ? W ?
W W
N
Ma
Y
Y
Y Y
Y=f(N)
AS
N2 Y1
P2
N1
O
Y1
N1
45。
Y1
Y1
P1
W2
w1
Ns(W1/P1 )
Ns(W2/P2 )
Nd(W2/P2 )
Nd(W1/P1 )
6.2 AS Function
? Keynesian AS curve
?Shape, a sloping-up line
?Preconditions,
? Monetary wage is constrained to contract
? Ns>Nd ? firm follows the contract and there is no
change in w；
? Ns<Nd ? workers follow the contract and there is no
change in w,
W W
N
Ma
Y
Y
Y Y Y=f(N)
AS
N2 Y1
P2
N1
O
Y1
N1
45。
Y1
Y1
P1
W2
w1
Ns(W1/P1 )
Nd(W2/P2 )
Nd(W1/P1 )
N2
Y2
Y2
6.3 AS-AD Model
?Classical AS-
AD Model,
?AD doesn’t
create
employment
and output,
?Y depends
on AS
P
P1
P2
AS
AD2
AD1
Y Y*
0
? Keynesian
AS-AD
model,
? AD does
create
employment
and output
? Y depends
on AD
P
P1
P2
AS
AD2
AD1
Y Y2
0 Y
1
6.3 AS-AD Model
6.3 AS-AD model
?Short-term
AS-AD
model,
?E1,
depression
?E2,
overheating
P
P2
P1
SAS
AD2
AD1
Y Y*
0 Y
1 Y2
LAS
E2
E1
6.3 AS-AD model
?Short-term
AS-AD
model,
?E1：
economic
flourish
?E2：
stagnation
and
inflation
P
P2
P1
SAS2
SAS1
AD
Y Y*
0 Y
2 Y1
LAS
E2
E1
? Price curve,change very slowly in short-
term
? AD curve,changeable during a short time
span
? AS curve,represents a country’s potential
productive capacity,We can regard it as
fixed one,
6.4 Price Changes and the
Determination of Output
6.4 Price Changes and the
Determination of Output
P0
O
P
E1 E0
Y Y1
AS
E3 AD2
AD0
AD1
Y2
6.5 Price Adjustment Process
? Price is the result of the interaction
between supply and demand,When
demand exceeds potential supply
capacity,producers will raise the price,
Otherwise the price will fall,The
difference between real output and
potential productivity forms market
pressure,
? When the pressure is positive,price will
rise ; otherwise price will fall,
m a r k e t p r e s s u r e /Y Y Y??（ ）
Effects between price and output
Pt=P(Yt-1) Yt=Y( Pt,AD)
Pt+1=P(Yt)
Pt+2=P(Yt+1)
Yt+1=Y(Pt+1,AD)
Yt+2=Y(Pt+1,AD)
6.5 Price Adjustment Process
? In order to maximize profits,firms will
determine the price of goods,Suppose the
price at time t is Pt,In a competitive market
firms will refer to the popular price in the market
before they determine their own price,Suppose
this popular price is, If firms believe the
market price completely,they will take it as their
own price,
tP
~
tt PP
~?
6.5 Price Adjustment Process
? But in fact,firms will adjust Pt according to
their own belief,
)(1~ 1
Y
YY
f
P
P t
t
t ??? ?
6.5 Price Adjustment Process
? For simplicity,suppose the prevalent
price predicted is the real price of last
year,we have
)(1 1
1 Y
YY
f
P
P t
t
t ??? ?
?
1
1 )}(1{
?
? ???
t
t
t PY
YYfP
?
6.5 Price Adjustment Process
? This implies that current price is
influenced by the price in last period and
the change of price is the result of
market pressure,
? Do some transformation we can get
inflation rate,
)( 1
1
1
Y
YYf
P
PP t
t
tt ???? ?
?
??
6.5 Price Adjustment Process
Meanwhile,inflation is not only the results
of market pressure but also,to a great
extent,the expectation people have
et
Y
YY
f ?? ?
?
? ? )( 1
6.5 Price Adjustment Process
AS
E2
AD
Y1
P0
O
P
E3
E1
E0
Y0 Y2 Y3
P1
P2
P3
Y
Economy overheating
AS
E2
AD
Y1
P3
O
P
E3
E1
E0
Y0 Y2 Y3
P2
P1
P0
Y
6.5 Price Adjustment Process
Economy depression
6.5 Price Adjustment Process
Y0
t
Y
Y
-
Y0
t
Y
Y
-
P*
t
P0
P
-
P*
t
P0
P
When economy is overheating
output decreases gradually to the
equilibrium level,and price also
maintain at the level P*
As the result of the inflation
expectation,price increases
quickly and output decreases
below the equilibrium rapidly
33
Chapter 6
The End
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90 91 92 93 94 95 96 97 98 99 00