Lecture Notes on Aggregate Demand and Aggregate Supply

Introduction

• Speaker: Mr. Willis
• Overview of economic indicators and performance measurement.
• Focus on the Aggregate Demand and Aggregate Supply (AD-AS) graph.

Aggregate Demand and Aggregate Supply Graph

• Visual representation of an economy's performance.
• Key components include:
  • Long-Run Equilibrium: Where aggregate quantity supplied equals aggregate quantity demanded at an optimal price level.
  • Potential Real GDP Output: Maximum output when resources are fully employed.

Key Components of the AD-AS Graph

• Long Run Aggregate Supply Curve: Represents the potential real GDP with full employment.
  • Labeled as Quantity Full Employment (QF).
• Short-Run Equilibrium: Intersection of Aggregate Demand and Short-Run Aggregate Supply indicates current GDP production level.

Disequilibrium in the Economy

• Price Level (P1): Optimal price level where quantity demanded equals quantity supplied.
• Types of Disequilibrium:
  1. GDP Surplus: High price levels lead to excess supply.
     • Causes: Decreased demand due to higher prices.
     • Market correction: Firms lower prices, increasing demand until equilibrium is reached.
  2. GDP Shortage: Low price levels lead to excess demand.
     • Causes: Increased demand due to lower prices.
     • Market correction: Firms raise prices, decreasing demand until equilibrium is reached.

GDP Surplus Example

• At Price Level P2: Excess supply occurs, leading to a surplus of GDP output.
• Market forces push prices down to restore equilibrium.

GDP Shortage Example

• At Price Level P2: Excess demand occurs, leading to a shortage of GDP output.
• Market forces push prices up to restore equilibrium.

GDP Gaps

• Definition: Differences between actual GDP and full employment GDP.
• Types of Gaps:
  • Positive GDP Gap (Inflationary Gap): Economy produces above its potential.
    • Results in overheating and rising prices.
  • Negative GDP Gap (Recessionary Gap): Economy produces below its potential.
    • Indicates underutilized resources and rising unemployment.

Economic Indicators Related to GDP Gaps

1. Unemployment Rate:

   • At QF: Unemployment rate of 4-6% (full employment).
   • If GDP < QF: Unemployment > 6% (recession).
   • If GDP > QF: Unemployment < 4% (inflation).

2. National Income Level:

   • Directly related to employment levels.
   • GDP < QF: National income decreases (recession).
   • GDP > QF: National income increases (inflation).

3. Consumption Levels:

   • Aggregate consumer spending is influenced by income and employment levels.
   • GDP < QF: Consumption decreases (recession).
   • GDP > QF: Consumption increases (inflation).

4. Standard of Living:

   • Measured by real GDP per capita.
   • GDP < QF: Standard of living decreases.
   • GDP > QF: Standard of living increases.

Practical Examples of GDP Gaps

• U.S. Economy Case:

  • Income tax reduction leads to increased consumer spending.
  • Results in inflationary gap: higher GDP, lower unemployment, increased national income, rising consumption and standard of living.

• Canadian Economy Case:

  • Reduction in subsidies leads to decreased production levels.
  • Results in recessionary gap: lower GDP, higher unemployment, falling national income, decreased consumption and standard of living.

Conclusion

• Importance of understanding AD-AS graph for economic analysis.
• Encouragement to subscribe and engage for further learning on macro and microeconomics.