Aggregate Demand

Aggregate Demand Curve

AD: is the demand by consumers, businesses, government and foregin countries
AD=  C + I
y axis: price level
x axis: Real Domestic output

Changes in price level cause a move along the curve not a shift of the curve

Aggregate Demand (AD)

• 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 banks was $50,000, but inflation erodes your purchasing power, you will likely reduce your spending. 
1. 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 price lead to an increase in the interest rate from 5% to 25%. You are less likely to take out loans to improve your business.  
2.  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 price triple in the US, Canada will no longer buy US goods causing quantity demanded of US products to fall. 

Shifts in Aggregate Demand (AD) 

There are two parts to a shift in AD: 

• A change in C, I, G, and/for Xn
•  a multiplier effect that produces a greater chage than the originial change in the 4 components. 
• Incrase in Ad= AD

Determinant of AD

• Consumption
• Gross Private Investment
• Government Spending
• Ne tExporots 

Change in consumer Spending

• Consumer Wealth (Boom in the stock market..)
• Consumer Expectations 
• Household indebtedness (more combine debt)
• Taxes

Change in investment spending 

• Real interest rates (price of borrowing) 
• Future Business expectations
• Productivity and technology 

Change in Government Spending

• (War...)
• ( Nationalized Health CAare)
• (Decrease in defense spending...)

Change in Net Exports

• Exchange Rates
• national income compared to Abroad

Government Spending: More (AD goes right) Less (AD goes left)