Chapter 33 is about aggregate supply and aggregate demand. The model is used to explain short-run fluctuations in economic activity around its long run trend. The aggregate demand curve shows the quantity of food and services that households, firms, the government, and customers abroad want to buy at each price level, and the supply curve is the quantity of goods and services that firms choose to produce and sell at each price level.
Short run fluctuations are unpredictable, and these recessions cause real GDP as well as income, spending, and production falls, and unemployment rises. According to the model, the output of goods and services and overall level of prices adjust to balance aggregate demand and supply. The aggregate demand curve slopes downward because of the wealth effect, the interest rate effect, and the exchange rate effect. The wealth effect states that a lower price level raises the real value of household money holdings, stimulating consumer spending. The interest effect states that a lower price level reduces the quantity of money demanded, and as households convert money into interest bearing assets, interest rates fall, stimulating investment spending. The exchange rate effect states that as a lower price level reduces interest rates, the dollar depreciates, stimulating net exports.
Aggregate demand could be affected by any event or policy that raises consumption, investment, government purchases, or net exports at a given price level.
Long run aggregate supply is vertical; the quantity of goods and services supplied depends on the economy’s labor, capital, natural resources, and technology.
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