February 15, 2017

Aggregate Demand 

Aggregate Demand Curve:

*AD is the demand by consumers, businesses, government, and foreign countries

*Change in the price level cause a move along the curve, NOT a shift of the curve

Aggregate (AD):

• 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 the price level and the level of real GDP is inverse

Reasons Why AD is Downward Sloping

1. Wealth Effect

• Higher prices reduce purchasing power of $
• This decreases the quantity of expenditures
• Lower price levels increase purchasing power and increase expenditures
• Price Level +
• GDP Demand -

*EX: Price in bank $50,000, Inflation reduces purchasing power; you reduce spending

2. Interest Rate Effect

• As price level increases, lenders need to charge higher interest rates to get a REAL return on their loans

• Higher interest rates discourage consumer spending and business investment

*EX: Increase in prices leads to an increase in the interest rate from 5% to 25%. You are less likely to take out loans to improve your business.

3. Foreign Trade Effect

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

• Exports fall and imports rise causing real GDP demanded to fall (Xn Decreases)




*EX: If prices triple in the US ----> Canada no longer buys US goods ----> Quantity demanded of US products fall

Shifts in Aggregate Demand (AD)

• A change in C, Ig, G, and/or Xn

• A multiplier effect that produces a greater change than the original change in the 4 components

Increases in AD= AD ---->

Decreases in AD= AD <----

Determinants of AD

• Consumption (C)

• Change in Consumer Spending

• Consumer wealth (Boom in the stock market)

• Consumer Expectations (People fear a recession)

• Household Indebtedness (More Consumer Debt)

• Taxes (Decrease in Income Taxes)

• Gross Private Investment (Ig)

• Change in Investment Spending

• Real Interest Rates (Price of Borrowing $)

• If interest rates increase/decrease

• Future Business Expectations (High Expectations)

• Productivity and Technology (New Robots)

• Government Spending (g)

• War

• Nationalized Health Care

• Decrease in defense spending

• Change in Net Exports

• Exchange Rates (If US depreciates relative to its Euro)

• National Income Compared to Abroad (If importer or US has a recession)

• "If US gets a cold, Canada gets pneumonia"

Government Spending:

• More government spending (AD ---->)

• Less government spending (AD <----)