Unit 3 - Aggregate Demand

February 11, 2015

The aggregate demand 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.

Three reasons AD is downward sloping

• Real-Balance effect: When the price level is high households and businesses cannot afford to purchase as much output. When the price level is low households and businesses can afford to purchase more output
• Interest-Rate effect: A higher price level increase the interest rate which tends to discourage investment. A lower price level decreases the interest rate which tends to encourage investment.
• Foreign purchases effect: The higher the price level, an increase in demand for relatively cheaper imports.

Shifts in AD

• Two parts to a shift in AD
• A ∆ in C, Ig, G, and/or Xn
• A multiplier effect that produces a greater change than the original ∆ in the 4 components.
• Increase in AD = AD >
• Decrease in AD = AD <

Consumption

• Households spending
• Consumer Wealth: More spending (AD Shifts >)
• Less wealth: Less spending (AD Shifts <)
• Consumer expectations
• Positive Expectations: More spending (AD Shift >)
• Negative Expectations: Less spending (AD Shift <)
• Household indebtedness
• Less debt: More spending (AD Shift >)
• More debt: Less spending (AD Shift <)
• Taxes
• Less taxes: More spending (AD Shift >)
• More taxes: Less spending (AD Shift <)

Gross private investment

• Te real interest rate
• Lower real interest rate: More investment (AD Shift >)
• Higher real interest rate: Less investment (AD Shift <)
• Expected returns
• Higher expected returns: More investment (AD Shift >)
• Lower expected returns: Less investment (AD Shift <)

Government spending

• More government spending (AD Shift >)
• Less government spending (AS Shift <)

Net exports

• Exchange rates (International value of $)
• Strong $ : More Imports and fewer exports (AD Shift <)
• Weak $ : Fewer imports and more exports ( AD Shift >
• Relative income
• Strong Foreign Economies: More exports (AD Shift >)
• Weak Foreign Economies: Less exports (AD Shift <)