Shifts in Aggregate Demand

Any changes in planned Aggregate Expendi­tures (vertical shifts in Keynesian cross dia­grams) that do not originate from changes in the price level cause horizontal shifts of the Aggregate Demand curve. Thus, spending plans ultimately determine the magnitude of Aggregate Demand. Shifts of the Aggregate Demand curve are caused by changes in mone­tary or fiscal policies or by changes in planned consumption, investment, or foreign spending.

Plans to spend more originate in tax cuts, increases in government purchases or transfer payments, or more optimistic expecta­tions by consumers and investors. Expansionary monetary policies such as open-market pur­chases of bonds or reductions in either reserve requirements or the discount rate also increase Aggregate Demand. Conversely, when the gov­ernment pursues contractionary monetary or fiscal policies, the Aggregate Demand curve shifts to the left.

THE AGGREGATE SUPPLY CURVE

Classical theory relies onmarket adjustments to changes in individual supplies and demands to keep an economy close to full employment. Thus, it predicts a vertical long-run Aggregate Supply curve. Keynesian theory deals with a de­pressed economy —so many resources are idle that Aggregate Supply is horizontal in the short run. An intermediate position is that Aggregate Supply is positively sloped.

In the short run, the Aggregate Supply curve reflects a positive relationship between the price level and the real quantity of National Output.

This short-run positive relationship occurs pri­marily because production costs (e.g., wages) are sticky relative tooutput prices when demand changes. Increases to Aggregate Demand cause movements of the AD curve up along the Aggregate Supply curve in which prices rise more quickly than wages, so higher profit per unit induces more output. Declines in Aggregate Demand reverse these movements along the Aggregate Supply curve: prices fall more quickly than costs, so profits decline and firms reduce production.

National Output and the Work Force

Increases in the total demand for laborgener­ate pressure for more employment and output and for hikes in wages and prices as well. Conversely, declines in the economy-wide de­mand for labor create pressure for lower em­ployment, output, wages, and prices. There are, however, differences between short-run and long-run adjustments. Understanding Aggre­gate Supply requires an appreciation of these differences.

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