Aggregate Demand

2-12-16

graph on paper

Aggregate demand- is the demand by consumers, businesses, government, and foreign countries

Aggregate- total

Graph

-Downward Slopping

3 reasons why AD is Downward slopping

1. Real-Balance Effect+ Higher price levels reduce the purchasing power of money, this decreases the quantity of expenditures, lower price  levels increase purchasing power and increase expenditures

Ex. If the balance in your bank was $50,000 , but inflation erodes your purchasing power, you will likely reduce your spending.

2. Interest-Rate Effect= When the 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. Why?

Ex. An increase in prices leads toan increase in the interest rate from 5% to 25%. You are less likely to take out loans to improve your business.

     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 US, Canada will no longer buy US goods.

Shifters of Aggregate Demand

GDP=C+I+G+Xn

2 Parts to a Shift

1. A Change in C, Ig, G, and/or Xn
2. A multiplier effect that produces a greater change than the original change in the 4 components

Increase in AD it will shift to the right

Decrease in AD it will shift to the left

*same thing as demand

graph on paper

What causes the graph to shift?

Household Spending is affected by:

Consumer Wealth

More Wealth = more spending (AD shifts Right,  Increasing)

Less Wealth = less spending (AD shifts Left, Decreasing)

Consumer Expectations

Positive Expectations= more spending(AD shifts Right,  Increasing)

Negative Expectations = less spending (AD shifts Left, Decreasing)

Household Indebtedness

Less Debt = more spending (AD shifts Right,  Increasing)

More debt = less spending (AD shifts Left, Decreasing)

Taxes

Less Taxes = More Spending (AD shifts Right,  Increasing)

More Taxes = less spending (AD shifts Left, Decreasing)

Gross Private Investment

Investment Spending is sensitive to:

The  Real Interest Rate

Lower Real Interest Rate = More Investment (AD shifts Right,  Increasing)

Higher Real Interest Rate = Less Investment (AD shifts Left, Decreasing)

Expected Returns

Higher Expected Returns = More Investment (AD shifts Right, Increasing)

Lower Expected Returns = Less Investment (AD shifts Left, Decreasing)

Expected Returns are influenced by

• Expectations of future profitability
• Technology
• Degree of Excess Capacity (Existing Stock of Capital)
• Business Taxes

Government Spending

More Government Spending (AD shifts Right, Increasing)

Less Government Spending (AD shifts Left, Decreasing)

Net Exports

Net Exports are sensitive to:

Exchange Rates (International value of $)

Strong $ = More Imports and Fewer Exports = (AD shifts Left, Decreasing)

Weak $ = Fewer Imports and More Exports= (AD shifts Right, Increasing)

Relative Income

Strong Foreign Economies = More Exports = (AD shifts Right, Increasing)

Weak Foreign Economies = Less Exports = (AD shifts Left, Decreasing)