Unit 3: Aggregate Demand

2/16/17

Aggregate Demand

• AD is the demand by consumers businesses, government and foreign countries.
• Changes in the price level cause a move along the curve not a shift of the curve.
• Aggregate Demand- Shows the amount of real GDP that the private, public , and foreign sector collectively desire to purchase at each possible price level.
• The relationship between price level and the level of real GDP is inverse.
• 3 Reasons why AD is Downward Slopping

1. Wealth Effect

-Higher prices reduce the purchasing power of money

-This decreases the quantity of expenditures
-Lower price levels increase purchasing power and increase expenditures

    

 2. Interest Rate Effect

- As price levels increase, lenders need to charge a higher interest rate to get a real return on their loans 

- Higher interest rates discourage consumer spending and business investments 

 3. Foreign Trade Effect

- When US price level rises, foreign buyers purchase fewer US goods and Americans buy more foreign goods 

- Exports fail and imports rise causing real GDP demanded to fall

• Shifts in Aggregate Demand

-There are 2 parts to shift in AD

- a change in  C.Ig,G, and/or Xn

-a multiplier effect that produces a greater change than original change in 4 components 

- Increase in AD= Right shift   Decrease in AD= Left shift in AD
2/17/17

• Determinants of AD

- Consumption (C)
- Gross private investment (Ig)
-Government (G)
- Net Exports (Xn)

• Consumption- Change in consumer spending 
  

- Consumer wealth: boom in stock market
- Consumer expectation: people fear a recession
- Household indebtedness: more consumer debt
- Taxes: a decrease in income tax

• Gross private investments- change in investment spending

- Real interest rates (price of borrowing money), if interest rates increase if interest rates decrease
- Future business expectations: high expectations
- Producing: productivity technology- new robots
- Business taxes: higher corporate taxes
- Government- Change in government spending
- War, national health care, decrease in defense spending.

• Net exports- change in net exports(x-m)

-exchange rates: if the US dollars depreciate it is relative to zero
- National income compared too abroad, if a major importer has a recession , if US has a recession
-" If the US gets cold Canada gets pneumonia."
AD= GDP=C+L+G+Xn

• Government Spending 

- more government spending= AD increasing
-less government spending = AD decreasing