SHORT RUN AND LONG RUNROLE OF AGGREGATE DEMAND

GROUP MEMBERS

Mohammad Zubair 14772Abbas Khozema 13210

Syed Saad Tabrez 14150 Mohammad Jawad 14883

Derivation of AD curveM * V = P * Y

Two assumptions:1. Let velocity(V) constant.2. Let money supply(MS) be fixed.Then P and Y have a negative relation in

order to keep the equation balance. P Y

Derivation of AD curve

SHORT RUN

•Prices are fixed in short run

•A.S curve is horizontal

SHORT RUN

1. Shifts in A.D, effects the output level but not the price level.

2. If A.D shifts outward, output increases and if A.D shifts inwards, output decreases.

3. Firms are willing to sell different quantities at constant price.

LONG RUN

Prices are flexible in long run

A.S curve is vertical.

LONG RUN

1. Shifts in A.D, effects the prices but not the output level.

2. If A.D shifts outward, prices increases and if A.D shifts inwards, prices decreases.

3. Firms are willing to sell constant quantity at different prices.

SHOCKS TO A.D

1. Shocks in A.D occur in the short run when people tend to hold lesser money and spend more.

2. Which means increasing the velocity while money supply is held constant V= 1/k

1. As velocity increases, it shifts the A.D curve from A to B (outwards).

2. Increasing the output from Y’ to y while holding the price constant.

3. As firms cost increases, they increase the price from P’ to p, decreasing the output from y to Y’. Hence, shifting the equilibrium from B to C.

AD in KEYNESIAN CROSS

1.A.D is planned expenditure.

2.Y(output) is actual expenditure

3.Slope of A.D depends on MPC

SHIFTS in AD in KEYNESIAN CROSS

A.D can shift upwards or downwards if there is:

1. A change in autonomous consumption.2. A change in investment( due to lower or higher interest

rate).3. A change in government spending( either expansion or

contraction of fiscal policy).4. A change in taxes.5. Changes in import and exports.

A.D curve also shifts when there are shifts in IS and LM curve.

Shifts in IS and LM curve are due to

1. Monetary policy (change in money supply) 2. Fiscal policy (change in G and T)