The reasoning used to construct the aggregate supply curve differs from the reasoning used to construct the supply curves for individual goods and services. The supply curve for an individual good is drawn under the assumption that input prices remain constant. The aggregate supply curve, however, is defined in terms of the price level.
The Circular Flow Diagram Studying macroeconomics allows students to see how the individual pieces of the economy fit together. The economy is large and complex, but by breaking the economy into its individual components, we can understand how it works.
To understand better how the macroeconomy functions, we examine a simple illustration called the circular flow diagram, graphed in Figure 1. The top half of the circle describes the demand for goods and services and the bottom half describes the production and income process.
We will follow the circle going clock-wise, beginning with consumption. We will see where that income comes from shortly. Consumers choose to either save S or consume C their disposable income.
By definition, the portion of disposable income that is not consumed is saved. As the diagram illustrates, saving "leaks out" into the financial system. Consumption is the purchase of newly produced goods and services for current enjoyment.
Going out to eat, buying the latest novel and purchasing a new pair of sneakers are examples of consumption. Unlike saving, the portion of disposable income that is consumed goes directly into the economy's circular flow.
The funds accumulated from saving are channeled through the financial system where they are lent out to investors through financial intermediaries such as banks or finance companies. Investment is the total amount spent by firms on newly produced factories, machinery, and plant and equipment.
Investment also includes the expenditures of households on new homes.
Investment must expand the production capacity of the economy. In contrast to consumption, investment is not for current enjoyment. As with consumption, the amount invested goes directly into the circular flow. The government also purchases newly produced goods and services.
These purchases--called government spending G --go directly into the economy's circular flow. Examples of government spending include the purchase of education services from teachers and administrators, the purchase of national defense including expenditures for the military and its weapons, the purchase of highway construction and maintenance services, and so on.
Government spending does not include government redistribution programs which are called transfer payments TR. Social security, Medicare, Medicaid, welfare and unemployment benefits are examples of transfer payments.
Finally, demand for U. Exports EX are newly produced goods and services purchased by people from other countries.
Examples include the purchase by a Canadian of a sport-utility-vehicle SUV produced in Detroit or the purchase by a Mexican of software from Microsoft. Of course, people in the U.
These purchases are called imports IM. The difference between exports and imports is called net exports NXwhich goes directly into the circular flow.
The four components in the top half of the circular flow diagram--consumption, investment, government spending and net exports--generate the demand for goods and services in the economy. Together they compose Aggregate Demand AD. Specifically, Aggregate Demand is the total amount that all consumers, firms, government, and foreigners wish to spend on final goods and services produced in the U.
The equation for Aggregate Demand is: Firms produce the goods and services that are demanded. The total amount of newly produced goods and services is the Gross Domestic Product Y.
The values of GDP and national income are equal because all the revenue that is earned from selling a final good or service ultimately ends up as income to someone in the economy. It goes to the owners of the software company. Households and firms have to pay taxes T on that national income.
The taxes flow to the middle of the circular flow diagram to the government.Macro Notes 5: Aggregate Demand and Supply Aggregate Demand, Aggregate Supply, and the Price Level Up until now, we have had no theory of the overall price level.
Aggregate’Demand • Aggregate demand is made up of four component parts: – consumption expenditure, the total demand for consumer goods and services – planned investment spending, the total planned spending by business firms on new machines, factories, and other capital goods, plus planned.
Ch 33 Aggregate Demand and Aggregate Supply Introduction Typically, increases in the labor force, increases in the. CHAPTER 7: AGGREGATE DEMAND AND AGGREGATE SUPPLY Learning goals of this chapter: • The long-run aggregate supply curve (LAS) is the relationship between Aggregate demand is the relationship between the quantity of real GDP demanded and the price level.
A change in the factors affecting any one or more components of aggregate demand i.e.
households (C), firms (I), the government (G) or overseas consumers and business (X) changes planned spending and results in a shift in the AD curve. Macro Notes 5: Aggregate Demand and Supply Aggregate Demand, Aggregate Supply, and the Price Level Up until now, we have had no theory of the overall price level.
We have a micro theory which will tell us about the prices of chicken or haircuts, but nothing about whether all prices will rise or fall.