I n t h I s c h a p t e r y o u w I l L

aggregate-supply curve
shows the quantity of
goods and services that firms produce and sell at each price level. According to
this model, the price level and the quantity of output adjust to bring aggregate de-
mand and aggregate supply into balance.
It may be tempting to view the model of aggregate demand and aggregate
supply as nothing more than a large version of the model of market demand and
market supply, which we introduced in Chapter 4. Yet in fact this model is quite
different. When we consider demand and supply in a particular market—ice
cream, for instance—the behavior of buyers and sellers depends on the ability of
resources to move from one market to another. When the price of ice cream rises,
the quantity demanded falls because buyers will use their incomes to buy prod-
ucts other than ice cream. Similarly, a higher price of ice cream raises the quantity
supplied because firms that produce ice cream can increase production by hiring
workers away from other parts of the economy. This 
microeconomic
substitution
from one market to another is impossible when we are analyzing the economy as
a whole. After all, the quantity that our model is trying to explain—real GDP—
measures the total quantity produced in all of the economy’s markets. To under-
stand why the aggregate-demand curve is downward sloping and why the
m o d e l o f a g g r e g a t e
d e m a n d a n d
a g g r e g a t e s u p p l y
the model that most economists
use to explain short-run
fluctuations in economic activity
around its long-run trend
a g g r e g a t e - d e m a n d c u r v e
a curve that shows the quantity of
goods and services that households,
firms, and the government want to
buy at each price level
a g g r e g a t e - s u p p l y c u r v e
a curve that shows the quantity of
goods and services that firms choose
to produce and sell at each price level

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C H A P T E R 3 1
A G G R E G AT E D E M A N D A N D A G G R E G AT E S U P P LY
7 0 7
aggregate-supply curve is upward sloping, we need a 
macroeconomic
theory.
Developing such a theory is our next task.
Q U I C K Q U I Z :
How does the economy’s behavior in the short run differ
from its behavior in the long run? 
◆
Draw the model of aggregate demand
and aggregate supply. What variables are on the two axes?
T H E A G G R E G AT E - D E M A N D C U R V E
The aggregate-demand curve tells us the quantity of all goods and services de-
manded in the economy at any given price level. As Figure 31-3 illustrates, the 
aggregate-demand curve is downward sloping. This means that, other things
equal, a fall in the economy’s overall level of prices (from, say, 
P
1
to 
P
2
) tends to
raise the quantity of goods and services demanded (from 
Y
1
to 
Y
2
).
W H Y T H E A G G R E G AT E - D E M A N D C U R V E
S L O P E S D O W N WA R D
Why does a fall in the price level raise the quantity of goods and services de-
manded? To answer this question, it is useful to recall that GDP (which we denote
as 
Y
) is the sum of consumption (
C
), investment (
I
), government purchases (
G
),
and net exports (
NX
):
Equilibrium
output
Quantity of
Output
Price
Level
0
Equilibrium
price level
Aggregate
supply
Aggregate
demand
F i g u r e 3 1 - 2
A
GGREGATE
D
EMAND
AND
A
GGREGATE
S
UPPLY
.
Economists use the model of
aggregate demand and aggregate
supply to analyze economic
fluctuations. On the vertical
axis is the overall level of prices.
On the horizontal axis is the
economy’s total output of
goods and services. Output
and the price level adjust
to the point at which
the aggregate-supply
and aggregate-demand
curves intersect.

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7 0 8
PA R T T W E LV E
S H O R T - R U N E C O N O M I C F L U C T U AT I O N S