Lecture 7 - GDP and Price level in short run and Long run | Macroeconomics- Learning and Analysis PDF Download

 Page 1


 
1 
 
 
 
 
 
 
 
Macroeconomics 
LESSON: GDP and Price level in short run & Long run 
LESSON DEVELOPER: MANJUL SINGH 
COLLEGE/DEPARTMENT: DEPARTMENT OF ECONOMICS 
SATYAWATI COLLEGE (EVENING) 
UNIVERSITY OF DELHI 
 
 
                                                  
 
 
 
 
 
 
 
 
 
 
Page 2


 
1 
 
 
 
 
 
 
 
Macroeconomics 
LESSON: GDP and Price level in short run & Long run 
LESSON DEVELOPER: MANJUL SINGH 
COLLEGE/DEPARTMENT: DEPARTMENT OF ECONOMICS 
SATYAWATI COLLEGE (EVENING) 
UNIVERSITY OF DELHI 
 
 
                                                  
 
 
 
 
 
 
 
 
 
 
 
2 
 
 
 
Table of Contents  
1. Learning Outcomes 
2. Aggregate Demand 
2.1 Derivation of Aggregate Demand Curve 
2.2 Shifts in Aggregate Demand Curve 
3. Aggregate Supply Curve  
3.1 Shift in aggregate supply curve 
4. Short run Aggregate supply Curve 
4.1 Shift in short run aggregate supply curve 
5. Long run Aggregate supply Curve 
6. Long run equilibrium 
7. Shift in Long run aggregate supply curve and long run Equilibrium 
8. Economic fluctuation: AS-AD models 
9. Stagflation and shift in SRAS 
10.Glossary 
11.References 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Page 3


 
1 
 
 
 
 
 
 
 
Macroeconomics 
LESSON: GDP and Price level in short run & Long run 
LESSON DEVELOPER: MANJUL SINGH 
COLLEGE/DEPARTMENT: DEPARTMENT OF ECONOMICS 
SATYAWATI COLLEGE (EVENING) 
UNIVERSITY OF DELHI 
 
 
                                                  
 
 
 
 
 
 
 
 
 
 
 
2 
 
 
 
Table of Contents  
1. Learning Outcomes 
2. Aggregate Demand 
2.1 Derivation of Aggregate Demand Curve 
2.2 Shifts in Aggregate Demand Curve 
3. Aggregate Supply Curve  
3.1 Shift in aggregate supply curve 
4. Short run Aggregate supply Curve 
4.1 Shift in short run aggregate supply curve 
5. Long run Aggregate supply Curve 
6. Long run equilibrium 
7. Shift in Long run aggregate supply curve and long run Equilibrium 
8. Economic fluctuation: AS-AD models 
9. Stagflation and shift in SRAS 
10.Glossary 
11.References 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
3 
 
 
 
 
 
1. Learning Outcomes 
After studying this topic, you will be able to: 
? Explain the meaning of the term Aggregate Demand and Aggregate supply. 
? Find out the shift in aggregate demand and aggregate supply curve with the help of 
proper diagram, 
? How long run aggregate supply curve works. 
? Understanding the economic fluctuation with AS-AD model. 
? Meaning of stagflation and shift in SRAS. 
? How an exogenous change in input price shift the short run aggregate supply curve. 
 
2 Aggregate Demand 
 
The concept of aggregate demand and Aggregate supply is used for analyzing the problem 
of inflation in an economy. Aggregate demand is the total spending which consumers, 
businessmen, government and foreigners are willing to make an aggregate output of goods 
and services produced in an economy at different price levels during a given period. In other 
words, the Aggregate demand tells us the quantity of goods and services people want to 
buy at any given level of prices. 
AD =C+I+G+NX, where C=goods demanded for the consumption purposes, I= goods 
demanded for the investment, G=goods demanded by the government, NX net export 
(export-import). 
For two sector economy, two sectors are the household and the firms. 
AD =C+I 
 
 For three sector economy, the three sectors are households, the firms and the government 
AD =C+I+G 
 
And for the four sector economy, households, the firms, the government and the foreign 
sector AD =C+I+G+NX 
 
The aggregate demand curve shows the relationship between price level and the quantity of 
goods and services demanded .Aggregate demand curve slopes downward. It means at 
higher price level, the total spending is less and at lower price levels the total spending or 
total purchase of aggregate output of goods is higher. 
Why the Aggregate Demand curve slopes downward? 
Page 4


 
1 
 
 
 
 
 
 
 
Macroeconomics 
LESSON: GDP and Price level in short run & Long run 
LESSON DEVELOPER: MANJUL SINGH 
COLLEGE/DEPARTMENT: DEPARTMENT OF ECONOMICS 
SATYAWATI COLLEGE (EVENING) 
UNIVERSITY OF DELHI 
 
 
                                                  
 
 
 
 
 
 
 
 
 
 
 
2 
 
 
 
Table of Contents  
1. Learning Outcomes 
2. Aggregate Demand 
2.1 Derivation of Aggregate Demand Curve 
2.2 Shifts in Aggregate Demand Curve 
3. Aggregate Supply Curve  
3.1 Shift in aggregate supply curve 
4. Short run Aggregate supply Curve 
4.1 Shift in short run aggregate supply curve 
5. Long run Aggregate supply Curve 
6. Long run equilibrium 
7. Shift in Long run aggregate supply curve and long run Equilibrium 
8. Economic fluctuation: AS-AD models 
9. Stagflation and shift in SRAS 
10.Glossary 
11.References 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
3 
 
 
 
 
 
1. Learning Outcomes 
After studying this topic, you will be able to: 
? Explain the meaning of the term Aggregate Demand and Aggregate supply. 
? Find out the shift in aggregate demand and aggregate supply curve with the help of 
proper diagram, 
? How long run aggregate supply curve works. 
? Understanding the economic fluctuation with AS-AD model. 
? Meaning of stagflation and shift in SRAS. 
? How an exogenous change in input price shift the short run aggregate supply curve. 
 
2 Aggregate Demand 
 
The concept of aggregate demand and Aggregate supply is used for analyzing the problem 
of inflation in an economy. Aggregate demand is the total spending which consumers, 
businessmen, government and foreigners are willing to make an aggregate output of goods 
and services produced in an economy at different price levels during a given period. In other 
words, the Aggregate demand tells us the quantity of goods and services people want to 
buy at any given level of prices. 
AD =C+I+G+NX, where C=goods demanded for the consumption purposes, I= goods 
demanded for the investment, G=goods demanded by the government, NX net export 
(export-import). 
For two sector economy, two sectors are the household and the firms. 
AD =C+I 
 
 For three sector economy, the three sectors are households, the firms and the government 
AD =C+I+G 
 
And for the four sector economy, households, the firms, the government and the foreign 
sector AD =C+I+G+NX 
 
The aggregate demand curve shows the relationship between price level and the quantity of 
goods and services demanded .Aggregate demand curve slopes downward. It means at 
higher price level, the total spending is less and at lower price levels the total spending or 
total purchase of aggregate output of goods is higher. 
Why the Aggregate Demand curve slopes downward? 
 
4 
 
 
 
Change in general price affect the purchasing power of money balances and monetary 
assets held by the people. With increase in general price level, the real value of monetary 
assets and money balances fall downward which make people feel poorer than earlier. This 
situation induced them to decrease their consumption which causes decrease in quantity of 
output purchase by them. In opposite condition if price levels decline then the real value of 
their monetary assets and many balances increases which encourage people to purchase 
more. This situation is called Real Balance Effect of price level. 
The second reason for the downward sloping of aggregate demand curve is the effect of 
change in general price level on the rate of interest, and through it on investment demand. 
In high price level situation the people will require extra money for operating a given 
amount of transaction; which leads to increase in demand of money for conducting 
transaction. The increase in demand for money causes for higher rate of interest .In this 
situation demand for investment in new capital goods will go downward. But in opposite 
situation when aggregate price falls in the economy, demand for money for transaction 
purpose will decrease which causes fall in rate of interest , so we can say that the  
investment demand and the  general price level are inversely related. 
Change in foreign demand for goods because of change in price level will lead to foreign 
trade effect. If general price level falls, the export will become cheaper leading to their 
increase .In short, fall in general price level will lead to more export and lesser imports 
causing expansion in aggregate demand. 
 
 
 
Page 5


 
1 
 
 
 
 
 
 
 
Macroeconomics 
LESSON: GDP and Price level in short run & Long run 
LESSON DEVELOPER: MANJUL SINGH 
COLLEGE/DEPARTMENT: DEPARTMENT OF ECONOMICS 
SATYAWATI COLLEGE (EVENING) 
UNIVERSITY OF DELHI 
 
 
                                                  
 
 
 
 
 
 
 
 
 
 
 
2 
 
 
 
Table of Contents  
1. Learning Outcomes 
2. Aggregate Demand 
2.1 Derivation of Aggregate Demand Curve 
2.2 Shifts in Aggregate Demand Curve 
3. Aggregate Supply Curve  
3.1 Shift in aggregate supply curve 
4. Short run Aggregate supply Curve 
4.1 Shift in short run aggregate supply curve 
5. Long run Aggregate supply Curve 
6. Long run equilibrium 
7. Shift in Long run aggregate supply curve and long run Equilibrium 
8. Economic fluctuation: AS-AD models 
9. Stagflation and shift in SRAS 
10.Glossary 
11.References 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
3 
 
 
 
 
 
1. Learning Outcomes 
After studying this topic, you will be able to: 
? Explain the meaning of the term Aggregate Demand and Aggregate supply. 
? Find out the shift in aggregate demand and aggregate supply curve with the help of 
proper diagram, 
? How long run aggregate supply curve works. 
? Understanding the economic fluctuation with AS-AD model. 
? Meaning of stagflation and shift in SRAS. 
? How an exogenous change in input price shift the short run aggregate supply curve. 
 
2 Aggregate Demand 
 
The concept of aggregate demand and Aggregate supply is used for analyzing the problem 
of inflation in an economy. Aggregate demand is the total spending which consumers, 
businessmen, government and foreigners are willing to make an aggregate output of goods 
and services produced in an economy at different price levels during a given period. In other 
words, the Aggregate demand tells us the quantity of goods and services people want to 
buy at any given level of prices. 
AD =C+I+G+NX, where C=goods demanded for the consumption purposes, I= goods 
demanded for the investment, G=goods demanded by the government, NX net export 
(export-import). 
For two sector economy, two sectors are the household and the firms. 
AD =C+I 
 
 For three sector economy, the three sectors are households, the firms and the government 
AD =C+I+G 
 
And for the four sector economy, households, the firms, the government and the foreign 
sector AD =C+I+G+NX 
 
The aggregate demand curve shows the relationship between price level and the quantity of 
goods and services demanded .Aggregate demand curve slopes downward. It means at 
higher price level, the total spending is less and at lower price levels the total spending or 
total purchase of aggregate output of goods is higher. 
Why the Aggregate Demand curve slopes downward? 
 
4 
 
 
 
Change in general price affect the purchasing power of money balances and monetary 
assets held by the people. With increase in general price level, the real value of monetary 
assets and money balances fall downward which make people feel poorer than earlier. This 
situation induced them to decrease their consumption which causes decrease in quantity of 
output purchase by them. In opposite condition if price levels decline then the real value of 
their monetary assets and many balances increases which encourage people to purchase 
more. This situation is called Real Balance Effect of price level. 
The second reason for the downward sloping of aggregate demand curve is the effect of 
change in general price level on the rate of interest, and through it on investment demand. 
In high price level situation the people will require extra money for operating a given 
amount of transaction; which leads to increase in demand of money for conducting 
transaction. The increase in demand for money causes for higher rate of interest .In this 
situation demand for investment in new capital goods will go downward. But in opposite 
situation when aggregate price falls in the economy, demand for money for transaction 
purpose will decrease which causes fall in rate of interest , so we can say that the  
investment demand and the  general price level are inversely related. 
Change in foreign demand for goods because of change in price level will lead to foreign 
trade effect. If general price level falls, the export will become cheaper leading to their 
increase .In short, fall in general price level will lead to more export and lesser imports 
causing expansion in aggregate demand. 
 
 
 
 
5 
 
2.1 Derivation of Aggregate Demand curve 
From the above discussion, it is clear that aggregate demand curve showing relationship 
between aggregate output demanded and general price level. Now here we derive 
aggregate demand curve by using Keynesian income-expenditure method. The Keynesian 
aggregate expenditure curve (C+I+G+Xn), expresses planned aggregate expenditure at 
different levels of National Income. The aggregate demand curve shows equilibrium 
aggregate expenditure at different price levels. And change in price level cause a change in 
quantity demanded through producing three effects, i.e. real balance effect, foreign trade 
effect and interest rate effect. 
Now suppose that price level falls, financial assets with fixed nominal valued which is held 
by the people will increase, by this people will start feeling themselves richer. So lower price 
level will make people to consume more at each level of National Income.