Aggregate Demand

Aggregate Demand

• Shows the amount of real GDP that the private, public, and foreign sector collectively desire to purchase at each possible price range.
• - The relationship b/w the price kevel and the level of real GDP is inverse.
• (X axis): PL for price level
• (Y axis): GDPr for Real GDP

 Reasons AD is Downward Sloping

• Real balances effects
•  when the price level is high, households and businesses cannot afford to purchase as much output
• When the prices level is low households and businesses can afford to purchase more outputs
• Interest Rate effect
• A higher price level increases the interest rate which tends to discourage investment
• A lower price level decreases the interest rate which tends to encourage investment
• Foreign Purchases effect
• A higher price level increases the demand for relatively cheaper imports
• A lower price level increases the foreign demand for relatively cheaper U.S exports

Shifts in Aggregate Demand (AD)

• There are two parts to a shift in AD
• a change in C, Ig, G and /or Xn
• A multiplier effect that the produces a greater change than the original change in the 4 components
• Increase in AD=AD →
• Decrease in AD = AD ←

Determinants of AD

CONSUMPTION

• House spending is affected by
• Consumer Wealth
•     More wealth = more spending (AD shifts →)
•     Less Wealth = less spending (AD shifts ←)
• Consumer Expectations
•      Positive expectations = more spending (AD shifts →)
•      Negative expectations= less spending (AD shifts ←)
• Household Indebtedness
•      Less debt = more spending (AD shifts →)
•      More debt = less spending (AD shifts ←)
• Taxes
•      Less taxes = more spending (AD shifts →)
•      More taxes = less spending (AD shifts ←)

GROSS PRIVATE INTEREST RATE

• Interest Spending Is Sensitive to:
• The Real Interest Rate
•    Lower interest rate = more investment (AD→)
•    Higher int. Rate = less investment (AD ←)
•    Expected Returns
•      Higher expected returns = more investment (AD→)
•     .Lower exp. Returns = less investment (AD ←)
• . Weak foreign economic = less exports = (AD ←) Returns are Influenced by:
• Expectation of future profitability
• Technology
• Degree of excess Capacity (existing stock of capital)
• Business Taxes

GOVERNMENT SPENDING

• ·More gov't spending (AD →)
• ·Less gov't spending (AD←)

NET EXPORTS

• Net exports are sensitive to:
• Exchange rates (international value of $)
•   Strong $ = more imports and fewer exports = (AD ←)
•   Weak $ = fewer imports and more exports = (AD→)
• -Relative income
• . Strong foreign economic = more exports = (AD→)