In chapter 33, aggregate demand and aggregate supply are discussed and a short run economic model is used to analyze economic fluctuations. All economies experience short-run economic fluctuations around long-run trends. They're irregular, unpredictable, and usually fluctuates with other macroeconomic quantities.. When recessions occur, real GDP and unemployment rises. Assumptions made based on classical economic theory (such as: nominal variables do not influence real variables) are true in the long run, but not in the short run. Therefore, economists must use a model of aggregate demand and aggregate supply to analyze short-run economic fluctuations. Aggregate demand will slope downwards because of the wealth effect (where a lower price level raises the real value of money holdings), interest-rate effect (which a lower price level reduces the quantity of money households demand), and exchange-rate effect (where the dollar depreciates in the market for foreign-currency exchange). The aggregate demand curve might shift because of changes in any of the factors that make up GDP: consumption, investment, government purchases, or net exports.
The aggregate supply curve slopes upward in the short run, as higher price levels lead to more goods and services produced. However, the supply curve is vertical in the long run because the amount of production will depend on capital and other factors of production. Aggregate supply could shift due to changes in labor, capital, natural resources, or technology. Both aggregate demand and aggregate supply are graphed with the price level on the y-axis and the quantity of goods (real GDP) on the x-axis.