Unit 3: Aggregate Demand

AD- is the demanded by consumers , business , government ,and foreign countries 

AD=C+Ig+G+Xn

• Changes in price level cause a move along the curve not a shift on 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 is AD 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 

(Ex.If the balance in your balance in your bank was $50k , but inflation erodes )

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 .

(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. 

Results.... price level goes up

3.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 

• There are two parts to a shift in AD 
• Change in C,Ig,G, and Xn 
• multipliers effect that produces a greater change then the original change in the 4 components 
• Increase in AD=AD→
• Decrease in AD=AD←

Determinants of AD

• Consumption(C)
• Gross private investments(Ig)
• Governments spending (G)
• Net exports (Xn)= Exports - Imports (X-M)

1. 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)

2. Change in investment spending 

• Real interest rates (price of borrowing $) 
• if interest rates increase 
• if interest rate decrease 
• Future business expections (High expections )
• Productivity and technology (new robots )
• Business taxes (Higher corporate taxes means )

3.Change in Government spending 

• (war..)
• (Nationalized Health Care )
• (Decreased in defense spending)

4.Change in Net Exports (X-M)

• Exchange rates (if the U.S dollar depreciates relative to the euro)
• National income compared to aboard ( if a major importer has a recession )
• (if the U.S has a recession )
• if the U.S get a cold,Canada gets pneumonia 
• AD=GDP=C+Ig+G+Xn 

Government spending 

• more gov't spending (AD→)
• less gov't spending (AD←)