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ECON 105 – Principles of Macroeconomics

Aggregate Demand and Aggregate
Supply (Ch. 14)

Junjie Liu – Econ 105

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Topics Covered
• Three Key Facts about Economic Fluctuations
• Economy in the Short Run and the Economy in the Long Run
• Aggregate Demand
• Aggregate Supply
• Three Theories for the Short-Run Aggregate Supply
• Using AD-AS Model to Explain Economic Fluctuations

Junjie Liu – Econ 105

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A Scenario…
If one household saves money, it can consume more in the future.
But if all households decide to save money, there will be a decrease in consumption. Then firms find themselves unable to sell the stuff they have produced, causing them to cut back on production and lay off workers. As output and income decrease, the total savings fall. The above scenario is an example of the fallacy of composition – what is true of the parts must be true of the whole.

Junjie Liu – Econ 105

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Economic Fluctuations
Economic fluctuations (aka business cycles): expansions and contractions in economic activities, such as output and employment.
• Expansions (or booms) are periods of economic upturns when output and employment are rising.
• Recessions (or contractions) are periods of economic downturns when output and employment are falling.
• A depression is a very deep and prolonged economic downturn.

Junjie Liu – Econ 105

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Economic Fluctuations

Peak = the highest point of real output during the business cycle.
Trough = the lowest point of real output during the business cycle.
Junjie Liu – Econ 105

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A Look at Short-Run Economic Fluctuations

Junjie Liu – Econ 105

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A Look at Short-Run Economic Fluctuations

Junjie Liu – Econ 105

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A Look at Short-Run Economic Fluctuations

Junjie Liu – Econ 105

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Three Key Facts about Economic Fluctuations
1) Economic fluctuations are irregular and unpredictable.
2) Most macroeconomic quantities fluctuate together.
When an economy enters a