Macroeconomics Unit III: Aggregate Demand

AGGREGATE DEMAND

• shows the amount of real GDP that the private, public, and foreign sector collectively desire to produce at each possible price level. 
• relationship between price level and level of real GDP is inverse.

AD Curve

Why is AD a downward slope?

• Real Balances Effect: when price level is high, households can't afford it. 
• Interest-Rate-Effect: a rise in price level increases the interest rate (discourages investment).
• Foreign Purchases Effect: a rise in price level increases the demand for cheap imports.

Shifts in AD (two parts)

1. change in C, IG, G, and/or Xn
2. a multiplier effect that produces a greater change than the original change in the four components. 

• increase in AD= AD →
• decrease in AD= AD ←

DETERMINANTS OF AD

Consumption

1. Consumer Wealth 

• more wealth: more spending AD →
• less wealth: less spending AD ←

     2.  Consumer Expectations

• positive expectations: more spending AD →
• negative expectations: less spending AD ←

     3.  Household Indebtedness

• less debt: more spending AD →
• more debt: less spending AD ←

     4.  Taxes

• less taxes: more spending AD →
• more taxes: less spending AD ←

Gross Private Investment

1. Real Interest Rate

• lower real interest rate: more investment AD →
• higher real interest rate: less investment AD ←

     2.  Expected Returns

• higher expected returns: more investment AD →
• lower expected returns: less investment AD ←
• influenced by expectations of future profitability, technology, degree of excess capacity( existing stick of capital), and business taxes.

Government Spending

• more government spending: AD →
• less government spending: AD ←

Net Exports

1. Exchange Rates (international value of money)

• weak money: less imports, more exports  AD →
• strong money: more imports, less exports AD ←

     2.  Relative Income

• strong foreign economy: more exports AD →
• weak foreign economy: less exports AD ←