macro economics








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Micro vs. Macro Economics

Micro – focuses in organization

Macro – fiscal & monetary policy




Shifts of the AD

AD moves to the left

AD moves to the right


Aggregate Demand (AD)

- is the total or aggregated quantity of output that is willingly bought at a given level of price, other things held constant.

It refers to the total amount that different sector in the economy willingly spend in a given period.


AD is the desired spending in all product sectors: consumption, private domestic investment, government purchases of goods and services, and net exports.


The AD curve slopes downward. This implies that real spending declines as the price level rises, other things held constant.

Real spending declines with a higher price level because of the effect of higher prices on real incomes, real wealth, and the real money supply.


Macroeconomic AD curves differ from their microeconomic cousin because aggregate demand relates prices and output for the entire economy while the micro curve analyzes the price and quantity for a single commodity. The AD curve slopes downward primarily because of the money-supply effect, while the micro demand curve slopes down because consumers substitute other goods for the good whose price has risen.



Shifts in AD


Factors that change aggregated demand include:

a) Macroeconomic policies, such as monetary and fiscal policies

b) Exogenous variables, such as foreign economic activity, technological advances, and shifts in asset markets.


When these variables change, thy shift the AD curve.


Determinants of the AD



Monetary policy

Increase in money supply lowers interest rates and relaxes credit conditions, including higher levels of investment and consumption of durable goods. In an open economy, monetary policy affects the exchange rate and net exports.


Fiscal policy

Increases in government purchases of goods and services directly increases spending; tax reductions or increases in transfers rise disposable income and induce higher consumption. Tax incentives like an investment tax credit can induce higher spending in a particular sector.


Exogenous variables

Foreign output

Output growth abroad leads to an increase in net exports.


Asset values

Rise in stock market increases household wealth and thereby increases consumption; also, this leads to lower cost of capital and increases business investment.


Advances in technology

Technological advances can open up new opportunities for business investment. Important examples have been the railroad, the automobile, and computers.



Political events, fee trade agreements, and the end of the cold war promote business and consumer confidence and increase spending on investment and consumer durables.






Shifts of the AS

AS moves to the left (Supply shocks)

AS moves to the right


Aggregated supply - refers to the total quantity of goods and services that the nation’s businesses willingly produce and sell in a given period.


Aggregated supply depends upon the price level, the productive capacity of the economy, and the level of cost.


Aggregated supply depends on the price level that businesses can charge as well as on the economy’s capacity or potential output. Potential output in turn is determined by the availability of productive inputs (labor and capital) and the managerial and technical efficiency with which those inputs are combined.


The AS curve tends to be vertical at potential output in the very long run but may be relatively flat in the short run.


Supply shocks – Is a sudden change in production costs or productivity that has a large and unexpected impact upon aggregated supply. As a result of a supply shock, real GDP and the price level change unexpectedly.


Determinants of AS




Supplies of capital, labor, and land are the important inputs. Potential output comes when unemployment of labor and other resources is at noninflationary levels. Growth of inputs increases potential output and aggregated supply.


Technology and efficiency

Innovation, technological improvement, and increased efficiency increase the level of potential output and raise aggregated supply.


Production cost



Lower wages lead to lower production costs; lower costs mean that quantity supplied will be higher at every price level for a given potential output.


Import prices

A decline in foreign prices or an appreciation in the exchange rate reduces import prices. This leads to lower production costs and raises aggregated supply.


Other input cost

Lower oil prices or less burdensome environmental regulations lowers production costs and thereby raises aggregated supply.











Open and closed economies


An economy that engages in international trade is called an open economy

A useful measure of openness is the ratio of a country’s exports or imports to its GDP




AS, AD, and the New Deal

blog post by Greg Mankiw


Paul Krugman has posted a nice note analyzing New Deal wage policies using the model of aggregate supply and aggregate demand familiar to teachers of undergraduate macroeconomics. The essence of Paul's argument is that the economy of the Great Depression was in a liquidity trap, which implies that the AD curve is vertical, which in turn implies that policies that adversely shift the AS curve do not affect equilibrium output in the short run. Thus, a policy that under normal circumstances would be bad, such as cartelizing the supply of labor, is not bad under the extraordinary circumstances of the 1930s. (See

Gauti Eggertsson

for a more sophisticated version of this line of argument.)


Even staying within the AD-AS model, it seems possible to argue the opposite point of view. Imagine you are a manager of a firm considering a long-term investment project. The President has just announced a policy to encourage your workers to form a cartel. How does that influence your decision to proceed with the project? Very likely, it deters you. Investment spending, however, is part of aggregate demand (in fact, one of the most volatile components). Thus, the policy could shift the AD curve, as well as the AS curve, in a contractionary direction.


As a general matter, the state of aggregate demand depends on an amorphous variable called confidence. Anything that threatens to screw up AS in the long run most likely reduces confidence and AD in the short run. The textbook separation of AD and AS is useful for focusing discussion in the undergraduate classroom, but events in the real world are rarely so clean.



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Next: Economics Basics: What Is Economics?


Table of Contents
1) Economics Basics: Introduction
2) Economics Basics: What Is Economics?
3) Economics Basics: Production Possibility Frontier, Growth, Opportunity Cost and Trade
4) Economics Basics: Demand and Supply
5) Economics Basics: Elasticity
6) Economics Basics: Utility
7) Economics Basics: Monopolies, Oligopolies and Perfect Competition
8) Economics Basics: Conclusion