What is Aggregate Demand and Supply?
Aggregate demand (AD) represents the total spending by consumers, businesses, and government at each price level, while aggregate supply (AS) shows the economy's total production capacity. Together, they determine the overall price level and real output of the economy.
Aggregate demand is the total spending at each price level, while aggregate supply is the total production available. Their intersection determines equilibrium price and output in the economy.
Step-by-step worked examples
At a price level of 100, AD = $2000B, AS = $1800B. Is there excess demand or supply?
AD ($2000B) > AS ($1800B) Excess demand of $200B Pressure for prices to rise
At equilibrium, the price level is 110 and output is $3000B. If AD increases to demand $3200B at this price, what happens?
New AD > Current AS Excess demand exists Price level rises to restore equilibrium
A supply shock reduces AS from $2500B to $2300B at price level 105. If AD = $2500B, what is the new equilibrium?
Shortage of $200B Price level will rise New equilibrium occurs at higher price, lower output
Flashcards
Quick quiz
Q1.If AD > AS, what happens in the economy?
Q2.Which of these shifts AD to the right?
Q3.A favorable technology shock shifts…
Q4.At equilibrium, what is true?
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Common mistakes
AD and AS always intersect at full employment. — Correct: They intersect at equilibrium, which may be above or below full employment.
Aggregate supply never changes. — Correct: Supply shifts with technology, input costs, and productivity changes.
Aggregate demand is the same as consumer demand. — Correct: AD includes consumers, businesses, government spending, and net exports.
A fall in price level always reduces real output. — Correct: Lower prices can increase output if demand increases (movement along AD, not a shift).
FAQ
What is aggregate demand and supply?
AD is total spending at each price level; AS is total production available. Their intersection determines equilibrium price and output.
What shifts the aggregate demand curve?
Changes in consumer wealth, business investment, government spending, or export demand shift AD.
What causes stagflation in the AD-AS model?
A supply shock (oil crisis) shifts AS left while AD stays the same, causing price rise and output fall simultaneously.
How does monetary policy affect the AD-AS model?
Central bank actions change money supply, shifting AD — lower rates increase AD, higher rates decrease it.