Demand Curve and Supply Curve Essay

2339 Words Jun 12th, 2013 10 Pages
Literature Review
Demand and supply have been generalized to explain macroeconomic variables in a market economy. The Aggregate Demand-Aggregate Supply model is the most direct application of supply and demand to macroeconomics. Compared to microeconomic uses of demand and supply, different theoretical considerations apply to such macroeconomic counterparts as aggregate demand and aggregate supply. The AD-AS or Aggregate Demand-Aggregate Supply model is a macroeconomic model that explains price level and output through the relationship of aggregate demand and aggregate supply. It is based on the theory of John Maynard Keynes presented in his work “The General Theory of Employment, Interest, and Money”. It is one of the primary simplified
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The horizontal axis represents the real quantity of all goods and services purchased as measured by the level of real GDP. Notice that the aggregate demand curve, AD, like the demand curves for individual goods, is downward sloping, implying that there is an inverse relationship between the price level and the quantity demanded of real GDP.
The standard supply curve and the aggregate supply curve
The standard supply curve is a graph showing the relationships between the price of a good and the quantity supplied. The supply curve slopes upward because other things equal, a higher price means a greater quantity supplied. The aggregate supply curve shows the relationship between the price level and the quantity of goods and services supplied in an economy. The equation for the upward sloping aggregate supply curve, in the short run, is Y = Ynatural + a (P - Pexpected). In this equation, Y is output, Ynatural is the natural rate of output that exists when all productive factors are used at their normal rates, “a” is a constant greater than zero, P is the price level, and Pexpected is the expected price level. This equation holds only in the short run because in the long run the aggregate supply curve is a vertical line, as output is dictated by the factors of production alone. An aggregate supply curve is shown in Figure 2.The aggregate supply curve equation means that output deviates from the natural rate of output when the price level deviates from the expected price

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