Aggregate Demand

AGGREGATE DEMAND CURVE

• Aggregate demand curves down.
• Y axis: Price Level
• X axis: Real GDP
• AD is the demand by consumers, businesses, government, and foreign countries. 
• Changes in price level cause a move along the curve, not a shift of the curve.
• Formula: AD = C + Ig + G + Xn

AGGREGATE DEMAND (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.
• 3 reasons why AD is downward sloping
• Wealth Effect
• Higher prices reduce the purchasing power of $.
• This decreases the quantity of expenditures.
• Lower price levels increase purchasing power and increase expenditures.
• Ex. If the balance in your bank account was $50,000, but inflation erodes your purchasing power, you will likely reduce your spending.
• So... Price Level goes up, GDP demanded goes down. 
• 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.
• Foreign Trade Effect
• When U.S. price level rises, foreign buyers purchase fewer U.S. 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 U.S. Canada will no longer buy U.S. goods causing quantity demanded of U.S. products to fall.

SHIFTS IN AGGREGATE DEMAND (AD

• There are two parts to a shift in 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.
• Increase in AD = AD shifts to the right
• Decrease in AD = AD shifts to the left

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...)
• (If interest rates decrease...)
• Future Business Expectations (High expectations...)
• Productivity and Technology (New robots...)
• Business Taces (Higher corporate taxes means...)
• Government Spending (G)
• Change in Government Spending
• More Government Spending (AD shifts to the right)
• Less Government Spending (AD shifts to the left)
• (War...)
• (Nationalized Health Care...)
• (Decrease in defense spending...)

• Net Exports (Xn) = Exports - Imports (X - N)
• Exchange Rates 
• (If the US dollar depreciates relative to the euro...)
• National Income Compared to Abroad
• (If a major importer has a recession...)
• (If the US has a recession...)
• "If the US gets a cold, Canada gets Pneumonia."
• Because everyone depends on the US to some degree.