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Unit 3: Aggregate Demand

Aggregate Demand curve:
-AD is demanded by consumers, businesses, government, and foreign countries
-Changes in price level move along curve not shifts on curve
Aggregate Demand (AD): Shows amount of real GDP that 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:
  1. Wealth Effect: higher prices reduce purchasing power of $, decreases quantity of expenditures, lower price levels increase purchasing power and increase expenditures ; ex: price level goes up, gdp demand goes down
  2. Interest-Rate Effect: as price level increase, lenders need to charge higher interest rates to get REAL return on their loans, higher interest rates discourage consumer spending and business investment ; ex: increase in price leads to increase in interest rate from 5% to 25%. Less likely to take out loans to improve 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 triple price in US, Canada will no longer buy US goods causing quantity demand of products to fall
Shifts in Aggregate Demand:
2 Parts to a shift: change in C, Ig, G and/or Xn and multiplier effect that produce greater change than original change in 4 components
increase in ad = ad right /// decrease in ad = ad left
Determinants of AD:
-Change in Consumer Spending: consumer wealth (boom in stock market), consumer expectation (people fear recession), household indebtedness (more consumer debt), Taxes (decrease in income taxes)
-Changes in Investment Spending: real interest rates (price of borrowing $; if interest rates increase/decrease...), future business expectations (higher expectation, productivity and technology (new robots...), business taxes (higher corporates mean..)
-Changes in Government Spending: War, Nationalized Health Care, Decrease in Defense Spending
-Change in Net Exports (X-N): exchange rate (if US dollar depreciates relative to euro...), National Income Compared to Abroad (if major importer has recession… /// if US has a recession…) “if US gets a cold, Canada gets Pneumonia”
AD=GDP=C+Ig+G+Xn
Government Spending: more = AD right & less = AD left

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