Aggregate Demand

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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.

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