Lecture on Aggregate Supply and Aggregate Demand

Introduction

• Focus on aggregate demand initially, followed by aggregate supply.
• Macro vs. micro context:
  • Aggregate demand/supply in macroeconomics vs. traditional demand/supply in microeconomics.
  • Macro: economy as a whole; Micro: specific market (e.g., candy bars).

Microeconomic Supply and Demand

• Market for Candy Bars (Micro):
  • Price per unit on the vertical axis.
  • Quantity bought/sold on the horizontal axis.
  • Demand Curve: Downward sloping.
    • High price: Low quantity demanded.
    • Low price: High quantity demanded.
  • Interpretations:
    • Substitution effect: People substitute goods based on price.
    • Marginal benefit: Willingness to pay decreases as quantity increases.

Aggregate Demand (Macroeconomics)

• Real GDP on the horizontal axis (total economy production).
• Price Level on the vertical axis (general price level in the economy).
• Aggregate Demand Curve: Downward sloping.
  • High price levels: GDP contracts.
  • Low price levels: GDP expands.
• Differentiation from Micro Demand: Not a substitution effect; different underlying factors.

Theories for Downward-Sloping Aggregate Demand

1. Wealth Effect:

   • Price drop = people feel wealthier = more demand for goods/services.
   • Price increase = people feel poorer = less demand for goods/services.

2. Interest Rate Effect:

   • Lower prices = more savings = more money to lend = lower interest rates.
   • Lower interest rates = more investments (e.g., building houses, factories) = GDP expansion.
   • Opposite effect for price increases.

3. Foreign Exchange Effect:

   • Lower prices = lower interest rates = investors convert currency seeking higher returns.
   • Weaker domestic currency = cheaper exports = increased demand for domestic goods/services.
   • Result: Increased GDP from higher net exports.
   • Opposite effect for price increases.

Conclusion

• Understanding aggregate demand and its drivers helps explain economic cycles.
• Importance of differentiating between micro and macro perspectives in economics.
• Aggregate demand plays a key role in determining overall economic activity and cycles.