# Relationship of aggregate demand and supply

In the short run, output fluctuates with shifts in either aggregate supply or aggregate demand; in the long run, only aggregate supply affects output. Can someone please summarize the relationships between money supply, aggregate demand, aggregate supply and interest rates?. Aggregate Demand(AD) is the total expenditure that the whole economy What is the relationship between the aggregate supply/aggregate demand model and .

The aggregate supply curve slopes up because when the price level for outputs increases while the price level of inputs remains fixed, the opportunity for additional profits encourages more production. Potential GDP, or full-employment GDP, is the maximum quantity that an economy can produce given full employment of its existing levels of labor, physical capital, technology, and institutions. Aggregate demand is the amount of total spending on domestic goods and services in an economy.

The downward-sloping aggregate demand curve shows the relationship between the price level for outputs and the quantity of total spending in the economy. Introduction To understand and use a macroeconomic model, we first need to understand how the average price of all goods and services produced in an economy affects the total quantity of output and the total amount of spending on goods and services in that economy.

The aggregate supply curve Firms make decisions about what quantity to supply based on the profits they expect to earn. Profits, in turn, are also determined by the price of the outputs the firm sells and by the price of the inputs—like labor or raw materials—the firm needs to buy.

Aggregate supply, or AS, refers to the total quantity of output—in other words, real GDP—firms will produce and sell. The aggregate supply curve shows the total quantity of output—real GDP—that firms will produce and sell at each price level. The graph below shows an aggregate supply curve. Let's begin by walking through the elements of the diagram one at a time: The graph shows an upward sloping aggregate supply curve. The slope is gradual between 6, and 9, before become steeper, especially between 9, and 9, The aggregate supply curve.

The vertical axis shows the price level.

Price level is the average price of all goods and services produced in the economy. It's an index number, like the GDP deflator. Wait, what's a GDP deflator again? The GDP deflator is a price index measuring the average prices of all goods and services included in the economy.

Notice on the graph that as the price level rises, the aggregate supply—quantity of goods and services supplied—rises as well. Why do you think this is? The price level shown on the vertical axis represents prices for final goods or outputs bought in the economy, not the price level for intermediate goods and services that are inputs to production.

The AS curve describes how suppliers will react to a higher price level for final outputs of goods and services while the prices of inputs like labor and energy remain constant. If firms across the economy face a situation where the price level of what they produce and sell is rising but their costs of production are not rising, then the lure of higher profits will induce them to expand production.

Potential GDP If you look at our example graph above, you'll see that the slope of the AS curve changes from nearly flat at its far left to nearly vertical at its far right.

At the far left of the aggregate supply curve, the level of output in the economy is far below potential GDP—the quantity that an economy can produce by fully employing its existing levels of labor, physical capital, and technology, in the context of its existing market and legal institutions.

At these relatively low levels of output, levels of unemployment are high, and many factories are running only part-time or have closed their doors. In this situation, a relatively small increase in the prices of the outputs that businesses sell—with no rise in input prices—can encourage a considerable surge in the quantity of aggregate supply—real GDP—because so many workers and factories are ready to swing into production.

The "long-run" is the period after which factor prices are able to adjust accordingly. The short-run aggregate supply curve has an upward slope for the same reasons the Keynesian AS curve has one: The long-run aggregate supply curve is vertical because factor prices will have adjusted. Factor prices increase if producing at a point beyond full employment output, shifting the short-run aggregate supply inwards so equilibrium occurs somewhere along full employment output. Monetarists have argued that demand-side expansionary policies favoured by Keynesian economists are solely inflationary.

### Relationship between money supply and aggregate demand | AnalystForum

As the aggregate demand curve is shifted outward, the general price level increases. This increased price level causes households, or the owners of the factors of production to demand higher prices for their goods and services. The consequence of this is increased production costs for firms, causing short-run aggregate demand to shift back inwards.

The theoretical ultimate result is inflation. In the short run wages and other resource prices are sticky and slow to adjust to new price levels. This gives way to the upward sloping SRAS. In the long-run, resource prices adjust to the price level bringing the economy back to a full employment output; along vertical LRAS.

Any event that results in a change of production costs shifts the curves outwards or inwards if production costs are decreased or increased, respectively. Some factors which affect short-run production costs include: These factors shift short-run curves exclusively.

Changes in the quantity and quality of labour and capital affect both long-run and short-run supply curves. A greater quantity of labour or capital corresponds to a lower price for both. A greater quality in labour or capital corresponds to a greater output per worker or machine. The long-run aggregate supply curve of the classical model is affected by events that affect the potential output of the economy.

## Relationship between money supply and aggregate demand

Factors revolve around changes in the quality and quantity of factors of production. Fiscal and monetary policy under Classical and Keynesian cases[ edit ] Keynesian Case: If there is a fiscal expansion i. The shift would then imply an increase in the equilibrium output and employment. In the Classical case, the AS curve is vertical at the full employment level of output.

Firms will supply the equilibrium level of output whatever the price level may be. Now, the fiscal expansion shifts the AD curve rightwards, thus leading to an increase in the demand for goods, but the firms cannot increase the output as there is no labour force which can be obtained. As firms try to hire more labour, they bid up wages and their costs of production and thus they charge higher prices for the output. The increase in prices reduces the real money stock and leads to an increase in the interest rates and reduction in spending.