İKTİSADA GİRİŞ II

Aggregate demand is the total amount of goods and services demanded at various price levels by all sectors in an economy (households, firms, government, and external world). The total amount of these goods and services is measured by real income or real GDP. As you will recall, the general level of prices is expressed by the average weighted index of prices of all goods and services in the economy. For example, the consumer price index (CPI) we are familiar with from our daily lives is an index that measures the change in the general level of prices. In this sense, aggregate demand explains the relationship between the general level of prices and the real income.

The aggregate demand curve is the curve showing the relationship between the general price level and the level of production. There is an inverse relationship between prices and production (real income). The inverse relationship between total production (real income) and the general level of prices is called the aggregate demand curve (AD).

In obtaining the aggregate demand curve, we have assumed that the variables of the economic policy that the government use are fixed. Changes resulting from government expenditure (G), taxation (T) and money supply (MS) due to monetary and fiscal policy decisions cause the aggregate demand curve to shift.

MS goes up=> AD shifts to the right

MS goes down => AD shifts to the left

G increases=> AD shifts to the right

T reduces=> AD shifts to the right

G decreases => AD shifts to the left

T goes up=>AD shifts to the left

There are different approaches among economists regarding the shape of the short-run aggregate supply curve, in other words, the slope of the short-run aggregate supply curve. Classical economists argue that the short-run supply curve is completely vertical or rather steep because the economy is always at full of employment as a result of dynamics of the market mechanism. According to this view, since the economy is in full employment, it is not possible to increase the total output even in the short-run. Keynesian economists argue that the supply curve is horizontal because the economy is underemployment GDP level. According to this view, it is possible to increase the total production without changing the general price level. When the economy moves from underemployment to full employment due to the increase in production, the general price level will start to rise. In this region where the elasticity of the short-run aggregate supply curve begins to decrease, the supply curve will have a positive slope.

There are different approaches among economists regarding the shape of the short-run aggregate supply curve, in other words, the slope of the short-run aggregate supply curve. Classical economists argue that the short-run supply curve is completely vertical or rather steep because the economy is always at full of employment as a result of dynamics of the market mechanism. According to this view, since the economy is in full employment, it is not possible to increase the total output even in the short-run. Keynesian economists argue that the supply curve is horizontal because the economy is underemployment GDP level. According to this view, it is possible to increase the total production without changing the general price level. When the economy moves from underemployment to full employment due to the increase in production, the general price level will start to rise. In this region where the elasticity of the short-run aggregate supply curve begins to decrease, the supply curve will have a positive slope.

Each factor affecting the firm’s production decisions causes the AS curve to shift. Some of these factors are cost shocks, economic growth, investment gap, natural factors and war.

Increase in Aggregate Supply

Decrease in Costs

- Decrease in input prices

- Low wage level

Economic Growth

- More capital

- More workforce

- Technological progress

Favorable Weather Conditions

In terms of economic stability, two main objectives emerge in today’s economic policy. These are the stability in prices and the stability in production. Price stability is the situation in which the general price level in the economy either changes very slowly or does not change at all. In today’s world it is generally accepted that a two percent annual increase in price level means prices are stable in the economy. Stability in production (output stability) is the reduction of periodic fluctuations in GDP and maintaining economic growth rate close to the long-term average.

Our goal is to assess the impact of economic policies. When analyzing these effects, we should pay attention to two points about AS curve. First of all, we assume that the AS curve does not change. Secondly, we have to pay attention to what region the economy is on the AS curve because the price and production reaction of the economy will be different accordingly. If the economy is operating in the horizontal part of the aggregate supply curve, as in the beginning, an expansionary policy that causes the AD curve to shift to the right leads to a small increase in prices and a large increase in production.

Inflation is the increase in the general level of prices. According to this definition, every factor that shifts the AD curve to the right and the AS curve to the left cause inflation. However, we should clarify the difference between one-time price increase and continuous increases in prices. Inflation is the continuous increases in the general price level for a long time. When you consider the explanations we made so far, it is possible to say that there will be a lot of factors that create one-time increase in prices. However, most of the economists today accept that the main factor that drives prices to increase continuously is continuously increasing money supply. This shows that whatever the initial reason to increase price level is, inflation occurs only when

increasing money supply accompanies. Therefore, it is generally accepted in economics that inflation is always a monetary phenomenon. After distinguishing one-time price increase and inflation, we can analyze the causes of inflation depending on its basic types.