Unit 3: Aggregate Demand

March 5, 2018

Aggregate Demand

Aggregate = total

• AD is the demand by consumers, businesses, government, and foreign countries.
• Changes in price level causes movement along the curve not shift of the curve.
• 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

1. Wealth Effect
• Higher prices reduce purchasing power of $.
• This decreases the quantity of expenditures.
• Lower price levels increase purchasing power and increase expenditures.
• Example: If the balance in you bank was $50,000 but inflation erodes your purchasing power, you will likely reduce your 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.
• Example: Increase in prices leads to an increase in the interest rate from 5%-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 for fall (Xn decreases)
• Example: If prices triple in the US, Canada will no longer buy US goods causing quantity demanded of US products to fall (AD).

Determinates of AD

• Consumption (C)
• Consumer Wealth (boom in stock market)
• Consumer Expectations (people fear a recession...)
• Household Indebtedness (more Consumer debt)
• Taxes (decrease in income taxes...)
• Gross Private Investment (Ig)
• Real Investment Rates (price of borrowing money)
• Future business Expectations (high expectations...)
• Productivity and Technology (new robots...)
• Business Taxes (higher corporate taxes means...)
• Government Spending (G)
• (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 US gets a cold, Canada gets pneumonia."