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

W
HY
D
OES THE
A
GGREGATE
-D
EMAND
C
URVE
S
LOPE
D
OWNWARD
?
1.
The Wealth Effect:
A lower price level increases real wealth, which encourages
spending on consumption.
2.
The Interest-Rate Effect:
A lower price level reduces the interest rate, which
encourages spending on investment.
3.
The Exchange-Rate Effect:
A lower price level causes the real exchange rate to
depreciate, which encourages spending on net exports.
W
HY
M
IGHT THE
A
GGREGATE
-D
EMAND
C
URVE
S
HIFT
?
1.
Shifts Arising from Consumption:
An event that makes consumers spend more
at a given price level (a tax cut, a stock market boom) shifts the aggregate-
demand curve to the right. An event that makes consumers spend less at a
given price level (a tax hike, a stock market decline) shifts the aggregate-
demand curve to the left.
2.
Shifts Arising from Investment:
An event that makes firms invest more at a
given price level (optimism about the future, a fall in interest rates due to an
increase in the money supply) shifts the aggregate-demand curve to the
right. An event that makes firms invest less at a given price level (pessimism
about the future, a rise in interest rates due to a decrease in the money
supply) shifts the aggregate-demand curve to the left.
3.
Shifts Arising from Government Purchases:
An increase in government
purchases of goods and services (greater spending on defense or highway
construction) shifts the aggregate-demand curve to the right. A decrease
in government purchases on goods and services (a cutback in defense or
highway spending) shifts the aggregate-demand curve to the left.
4.
Shifts Arising from Net Exports:
An event that raises spending on net exports
at a given price level (a boom overseas, an exchange-rate depreciation) shifts
the aggregate-demand curve to the right. An event that reduces spending on
net exports at a given price level (a recession overseas, an exchange-rate
appreciation) shifts the aggregate-demand curve to the left.

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7 1 2
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
Q U I C K Q U I Z :
Explain the three reasons why the aggregate-demand curve
slopes downward. 
◆
Give an example of an event that would shift the
aggregate-demand curve. Which way would this event shift the curve?
T H E A G G R E G AT E - S U P P LY C U R V E
The aggregate-supply curve tells us the total quantity of goods and services that
firms produce and sell at any given price level. Unlike the aggregate-demand
curve, which is always downward sloping, the aggregate-supply curve shows a
relationship that depends crucially on the time horizon being examined. 
In the long
run, the aggregate-supply curve is vertical, whereas in the short run, the aggregate-supply
curve is upward sloping.
To understand short-run economic fluctuations, and
how the short-run behavior of the economy deviates from its long-run behavior,
we need to examine both the long-run aggregate-supply curve and the short-run
aggregate-supply curve.
W H Y T H E A G G R E G AT E - S U P P LY C U R V E
I S V E R T I C A L I N T H E L O N G R U N
What determines the quantity of goods and services supplied in the long run? We
implicitly answered this question earlier in the book when we analyzed the
process of economic growth.