The document discusses the downward slope of the aggregate demand (AD) curve and the upward slope of the aggregate supply (AS) curve in the short run. The AD curve slopes downward due to the real balance effect, interest rate effect, and foreign trade effect as price levels rise. The AS curve is horizontal at low output levels as unused resources allow expansion without cost increases. It slopes upward between potential and full employment as bottlenecks and declining marginal productivity cause costs to rise. The AS curve is vertical at full employment when no further output gains are possible. Short-run macroeconomic equilibrium occurs where the AD and AS curves intersect at an output and price level.

2.  AD curve is downward
sloping because of the
reverse relationship
between price and
spending (AD).
 Why AD curve slopes
downward ?
 or
 Why aggregate demand
for output falls at higher
aggregate price?
AD
PRICE
LEVEL
Aggregate Output
Y1 Y2
P1
P2

3.  Real Balance Effect:
 With rise in general price level, the real value of
monetary asset will fall making people feel poorer
than before.
 Resultantly, they will consume less therefore
demand will go down as well AD slopes
downward.

4.  Rate of Interest Effect:
 At a higher price level, people will require more money for
purchasing and transaction purpose.
 This will lead to the increase in the demand for money for
transaction.
 At given the money supply, increase in demand of money
will cause the rate of interest to go up.
 At higher rate of interest, demand for investment in new
capital goods (machinery, plant , equipment) will decline.
 Resultantly AD will go down . Hence slope of AD is
downward .


5.  Foreign Trade effect :
 The rise in general price level will lead to decline in
export which reduces income and whereby aggre-gate
demand curve slopes downward.
 Increase in imports because of fall in price of imported
products will lead decline in demand . for domestic
products.

6.  There is direct
relationship
between price rise
and aggregate
supply.
 Short run AS
comprising of
three stages:
AS
Aggregate Output
AS
Vertical range
Horizontal
Range
Intermediate
Range
Capacity
Output
YFY
Price
Level

7. 1. Horizontal Range:
 As per Keynes, in horizontal range of output upto Y,
the economy can expand its production without facing
rise in unit cost of production because at this time
economy is in the grip of recession with high
unemployment and unutilized machinery.
 Since other resources are lying unused resultantly there
will not be higher cost per unit or rise in the price level if
aggregate output is expanded in the range.
 In depression while product prices and wages are
inflexible downward it is real output will fall and AS Will be
horizontal.

8.  Intermediate Range
 In this range (between Y and YF) increase in
aggregate output brings about rise in price level,
whereby AS curve is upward sloping. Because:
 As national production expands some industries,
like electronics and computer hardware may
experience shortage of skilled engineers.
 Due to shortage of engineers for some crucial
industries bottleneck in production may arise which
will push up the cost in these industires whereby
price level upward.

9.  In order to overcome shortage of skilled labour
less skillful workers may be employed resulting in
rise in unit cost of production.
 Before full employment of resources, some
industries may experience shortage of raw material
due to expansion of production encounters rising
unit cost of production.
 Most important factor responsible for rising cost is
the decline in marginal products of factor of labour
as more of them are employed in expanding
production.

10.  Vertical Range:
 As per classical economist In this range, AS is
perfectly inelastic or vertical at the full employment
level of output (YF)
 Vertical shape of AS curve implies that any further
rise in the price level will fail to cause any increase
in aggregate output because the economy is
already using its available resources fully and
producing its potential output.

11.  Short run macroeco-
nomic occurs at the
price level at which AD
= AS.
 At point E where AD
intersects AS at P0
price level and real GDP
is Y0, short-run equili-
brium is reached.
BA
E
C
D
Aggregate Output (Real GDP)
P2
P0
P1
AS
AD