1. Aggregate Demand, Aggregate Supply, and Business Cycles
Teaching Strategy: Be careful using the supply and demand analogy here. If you dont push it too far, using information that the students already know about market models can help introduce aggregate demand and supply, but they should not get the impression that the macro model is just the sum of individual markets. The underlying arguments in both cases are distinct.

1. Aggregate demand can produce a recession in the business cycle when it falls and thereby reduces equilibrium real GDP.
   
   
2. Aggregate supply can cause equilibrium real GDP to fall and thereby increase the price level.
   
   
3. The reasons for the shapes and movements of the AD and AS curves are different from those for the shapes and movements of the supply and demand curves.
   
   

2. Factors That Influence Aggregate Demand

1. Consumption spending depends on income, wealth, expectations, demographics, and taxes.
   
   
2. Investment depends on factors that determine its profitability.
   
   
3. Government spending is a key tool of fiscal policy, because it can be set by government officials independent of the level of income.
   
   Teaching Strategy: Show that government spending includes not only spending at the federal level but also state and local government spending.
   
   
4. Net exports are determined by income, domestic versus foreign prices, exchange rates, and government trade policies.
   
   
5. Aggregate expenditures are the sum of all spending on domestic goods and services.
   
   Teaching Strategy: Point out that aggregate expenditures form the foundation for the aggregate demand curve that will be discussed in the forthcoming section. Later you can show how changes in aggregate expenditure components shift the aggregate demand curve.
   
   

3. The Aggregate Demand Curve
The aggregate demand curve shows aggregate demand in relation to the price level.

1. Changes in aggregate quantity demanded: price-level effects
   
   Teaching Strategy: Note that the arguments that were used to establish a downward-sloping market demand curve do not make sense for an aggregate demand curve because market quantities respond to relative price changes while aggregate quantities respond to general price changes.
   
   

• The wealth effect is the effect where a price change causes the real value of wealth to change, resulting in a change in spending.
  
  
• The interest rate effect is the effect where, when prices go up, people need more money to make their purchases. They sell bonds to raise money, the supply of bonds increases, the price of the bonds falls, and the interest rate on the bonds increases. Higher interest rates then lead to lower investment and consumption.
  
  
• The international trade effect is the effect where a change in domestic prices relative to foreign prices can cause net exports to change.
  
  
• The sum of the price-level effects is that a lower (higher) price level leads to higher (lower) consumption, investment, and net exports.
  
  
• Changes in aggregate demand: nonprice determinants
  
  

Teaching Strategy: Make certain that your students distinguish between movement along an aggregate demand curve and a shift in the curve.

• Expectations
  
  
• Foreign income and price levels
  
  
• Government policy
  
  

4. Aggregate Supply
The positive relationship between price and national output is due to changes in profits.

1. Changes in aggregate quantity supplied (price-level effects): In the short run, resource prices are assumed to be constant, so an increase in product prices leads to an increase in profits and production.
   
   
2. Short-run versus long-run aggregate supply: In the long run, all costs are variable, so there is no variation in the level of real output with the price level.
   
   Teaching Strategy: Point out actual cases where prices will not rise as demand rises (for example, major fast-food chains). Provide examples where prices rise concurrently with increases in demand. Ask your students why businesses may not want to change prices when demand changes.
   
   

• The slope of the short-run aggregate supply curve becomes steeper as the level of real GDP increases.
  
  

Teaching Strategy: When you are discussing the shape of the aggregate supply curve, note that at any particular time, industries across the economy are producing at many different levels relative to their capacity. Hence, when demand increases, some industries will be able to increase production while others will quickly approach full capacity and will increase prices instead of production. As the economy approaches its potential level of output, more industries are at full capacity and raise prices in response to demand increases.

• The slope of the long-run aggregate supply curve remains constant as prices increase. In the long run, production costs fully adjust to price increases. As a result there is no variation in profits as prices change and thus no variation in real output.
  
  
• Changes in aggregate supply: nonprice determinants
  
  

• Resource prices
  
  
• Technology
  
  
• Expectations, especially as they affect wage demands, are critical in determining the position of the aggregate supply curve.
  
  

Teaching Strategy: Emphasize the role of expectations in shifting the aggregate supply curve. This will be important when the relationship between the long-run and short-run aggregate supply curves is discussed.

• The long-run aggregate supply curve shifts rightward over time as the potential output of the economy increases.
  
  

5. Aggregate Demand and Supply Equilibrium

1. Short-run equilibrium: When the short-run aggregate supply curve intersects the aggregate demand curve, the economy is at a short-run equilibrium price and output level.
   
   
2. Long-run equilibrium: The long-run equilibrium level of output is determined by the quantities of capital and labor and the level of technological development in the economy.