The Aggregate Model of Macro Economy


The long-run aggregate supply curve can never shift. This statement is true. First, Aggregate supply is the total amount of goods and services produced and supplied at a given price level in an economy. Decision-making on how much is produced in the long run and short run differs. Depending on the amount of labor and capital that the firm has, the firm will decide on the amount of output to produce in the long run. This is referred to as the natural rate of output. Hence in the long run the firm will only change the price of the goods in case of the demand changes without changing the output. The firm can also change the wage of its employees as a result of the changes in demand while the output remains the same.

The long-run aggregate supply curve is always vertical since the firms will not have any alternative amount to produce in regards to the price level but the prices will have to adjust to the companies’ desired amount of output.

The Keynesian portion of the short-run aggregate supply (SAS) curve would be the Recession period is characterized by a decline in the output level (GDP) and the rate of unemployment is high. This means that the rate of unemployment is high and the prices also are increasing. The Keynesian aggregate supply curve is the most applicable during the recession since it shows that full employment is maintained even when the prices are higher. There is a segment that is more horizontal which shows that the real production is less due to the price’s inflexibility. The graph below, it shows a curve with a slight positive slope not purely L-shaped. The horizontal part shows the Keynesian view of constant prices that do will bring about a reduction in demand that leads to a decrease in the output. The vertical part indicates the view of full employment due to the fact that there are fixed levels of resources used and the output is definitely restricted.


When there is an increase in the money wage rate the short-run supply curve will shift upwards. When there’s an increase in the wage rate of the employees they increase their spending. The aggregate supply curve slopes upwards with the increase in the prices and the wage rate of the employees. The real wage rate does not change. But since the workers will not easily notice the changes in their goods and services, but easily notices the change in their wage rate, their spending will increase. So long as there are imbalances in the prices of the real resources, the result is a shift in the short-run supply curve. When the incomes of the workers increase, with no change in prices, the real purchasing power of the worker’s increases and they will be enticed to increase the quantities of labor supply.

Wage rate

On the other hand, if the workers receive the same real wage, and the prices increases, their purchasing power is lower hence they will reduce the quantities of the supply of labor. Therefore, when there is an increase in the money wage rate, the short-run aggregate supply is decreased hence short-run aggregate supply curve shifts upward.

When there is a decrease in the money supply ceteris peribus, the aggregate demand curve will shift leftwards. This is because the Federal Reserve decreasing the money supply due to the fear of increasing inflation. This will definitely decrease the money in circulation hence decreasing the willingness of households, government, businesses and foreigners to purchase a particular commodity at a given price. The expenditures on consumption, net exports, money for investment, and money available for the government to spend will decrease hence there will be a reduction of the demand curve, which is the shift to the left in the demand curve.

Change in Aggregate Demand

Stagflation occurs when the aggregate demand (AD) curve shifts out on the upward sloping portion of the short-run aggregate supply (SAS) curve: (2 points).

Stagflation is when there is inflation and at the same time recession. That is there is a high rate of unemployment as well as increasing prices. Here the output is falling and the prices also are rising. This is mainly as a result of rising costs. Hence the occurrence of stagflation is when the aggregate demand curve shifts out of the upward sloping portion of the short-run aggregate supply curve.

  • Simple deposit multiplier = 1/rr = 1/0.2 = 5
  • Currency deposit ratio = 0.05 and the reserve ratio is 0.15

The money multiplier will be given by (0.05/0.15 + 0.95) = 1.28 Where 0.05 is the money deposited, 0.15 is the reserve, and 0.95 is the currency held by the people.

Hence this means that the money multiplier is 1.28. This implies that 95% of the money is held in cash, not in deposits. Therefore the money held as a deposit i.e. 0.05 will be multiplied by 1.28 to get the money supply through the 0.95 is still in circulation. The difference between the simple multiplier and the money multiplier is that the simple deposit multiplier is the money in circulation that is as a result of the money deposited in the bank issued as credit while the money multiplier is the measures the over money in supply as a result of the money released by the Federal reserve.


Aggregate demand and supply models, 2010. Web.

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