Key Concepts and Summary

Key Concepts and Summary

The upward-sloping short-run aggregate supply (SRAS) curve shows the positive relationship between the price level and the level of real GDP in the short run. Aggregate supply slopes up because when the price level for outputs increases, while the price level of inputs remains fixed, the opportunity for additional profits encourages more production. The aggregate supply curve is near-horizontal on the left and near-vertical on the right. In the long run, aggregate supply is shown by a vertical line at the level of potential output, which is the maximum level of output the economy can produce with its existing levels of workers, physical capital, technology, and economic institutions.

The downward-sloping aggregate demand (AD) curve shows the relationship between the price level for outputs and the quantity of total spending in the economy. It slopes down because of: (a) the wealth effect, which means that a higher price level leads to lower real wealth, which reduces the level of consumption; (b) the interest-rate effect, which holds that a higher price level will mean a greater demand for money, which will tend to drive up interest rates and reduce investment spending; and (c) the foreign price effect, which holds that a rise in the price level will make domestic goods relatively more expensive, discouraging exports and encouraging imports.

Glossary

aggregate demand (AD)

the amount of total spending on domestic goods and services in an economy

aggregate supply (AS)

the total quantity of output (i.e. real GDP) firms will produce and sell

aggregate demand (AD) curve

the total spending on domestic goods and services at each price level

aggregate supply (AS) curve

the total quantity of output (i.e. real GDP) that firms will produce and sell at each price level

aggregate demand/aggregate supply model

a model that shows what determines total supply or total demand for the economy, and how total demand and total supply interact at the macroeconomic level

full-employment GDP

another name for potential GDP, when the economy is producing at its potential and unemployment is at the natural rate of unemployment

long run aggregate supply (LRAS) curve

vertical line at potential GDP showing no relationship between the price level for output and real GDP in the long run

potential GDP

the maximum quantity that an economy can produce given full employment of its existing levels of labor, physical capital, technology, and institutions

short run aggregate supply (SRAS) curve

positive short run relationship between the price level for output and real GDP, holding the prices of inputs fixed