February 15, 2017

Aggregate Demand 

Graph aggregate demand curve

• AD is the demand by consumers, businesses, government & foreign countries. 
• change in price level cause a move along the curve NOT a shift of the curve. 

What is aggregate demand? 

• shows the amount of real GDP that the private, public, and foreign sector collectively desire to purchase at each possible price level. 
• relationship between the price level and the level of real GDP is inverse. 

3 reasons why AD is downward sloping?

1. Wealth effect 

• ↑ price reduce  purchasing power of $ 
• ↓ Quantity of expenditures 
• ↓ Price levels increase purchasing power and ↑ expenditures. 
• price level ↑, GDP demanded  

2. Interest Rate Effect 

• as price level ↑ , lenders need to charge ↑ interest rates to get REAL  return on their loans. 
• ↑ interest rates discourage consumer spending and business investment. 
• price level ↑ , GDP demanded ↓

3. Foreign Trade effect

• when US price ↑, foreign buyers purchase fewer US goods and Americans buy more foreign goods. 
• Export falls and import rise, causing real GDP demanded to fall. (Xn decreases) 

What is shift in AD? 

• 2 parts to shift in AD 
•  A change in C, Ig, G, and I  or Xn 
• A multiplier effect that produces a greater change than the original change in the 4 components 
• increase in AD = AD →
• decrease  in AD = AD ←

 What is increase in AD?
(GRAPH)

 What are the determinants of AD?

•  consumption
• Gross private investment
• Government spending
•  net exports

1.   Consumption

• consumer wealth ( boom in stock market)
• consumer expectations (people fear recession)
• household indebtedness  (more consumption debt)
• Taxes (decrease in income taxes)

2.  Change in investment spending

• Real interest rate  (Price of borrowing money)
• future businesses expectations
• productivity and technology

3.  Government spending

• war
• healthcare
• decrease in defense spending

4.  Change in net export

• Exchange rates
• National income compared to abroad

AD = GDP = C + I + G + Xn

 What about government spending?

• more government spending ( AD →)
• Less government spending (AD ←)