Macro Economics

Aggregate Demand & Supply I

Objectives

After working through this topic you should be able to:

• Understand the meaning and derivation of the aggregate demand curve

• Explain the factors that can cause the AD curve to shift

• Identify the microeconomic foundations of the aggregate supply curve

• Explain the importance of price expectations as a determinant of the supply of labour

• Distinguish between complete money illusion, imperfect foresight and perfect foresight as three cases of price expectations

|Key Concepts | |

|real money supply |money wage rate |

|aggregate demand curve |real wage rate |

|aggregate supply curve |expected price level |

|aggregate production function |coefficient of adjustment |

|labour market |complete money illusion |

|imperfect foresight |perfect foresight |

Introduction

In the IS/LM analysis it has been assumed that the general price level is fixed up to the point of full employment, after which it can rise without limit. Clearly this is an unacceptable assumption because since 1950 an axiom of economic life in advanced economies has been the existence of inflation during both booms and slumps. Moreover inflation has persisted even though high levels of unemployment have emerged since the mid 1970’s, i.e. stagflation. Therefore the general price level has to be explicitly analysed, and this is the purpose of the aggregate demand and supply framework. The...