Aggregate Demand and Aggregate Supply

This chapter introduces the Aggregate Demand/Aggregate Supply model of macroeconomics. Read the introduction and Section 1 to learn about Aggregate Demand and the three effects (weath, interest rate, and international trade) that cause the downward slope. Recall the difference between quantity demanded and demand - the same logic applies to Aggregate Demand. Identify the variables that change (shift) the Aggregate Demand curve. Read this chapter and attempt the "Try It" exercises. You will revisit certain sections of the chapter later in this unit.

Recessionary and Inflationary Gaps and Long-Run Macroeconomic Equilibrium


  1. Explain and illustrate graphically recessionary and inflationary gaps and relate these gaps to what is happening in the labor market.
  2. Identify the various policy choices available when an economy experiences an inflationary or recessionary gap and discuss some of the pros and cons that make these choices controversial.

The intersection of the economy's aggregate demand and short-run aggregate supply curves determines equilibrium real GDP and price level in the short run. The intersection of aggregate demand and long-run aggregate supply determines its long-run equilibrium. In this section we will examine the process through which an economy moves from equilibrium in the short run to equilibrium in the long run.

The long run puts a nation's macroeconomic house in order: only frictional and structural unemployment remain, and the price level is stabilized. In the short run, stickiness of nominal wages and other prices can prevent the economy from achieving its potential output. Actual output may exceed or fall short of potential output. In such a situation the economy operates with a gap. When output is above potential, employment is above the natural level of employment. When output is below potential, employment is below the natural level.