Unit 3 - Aggregate Demand (2-12-16)

Aggregate Demand: the demand by consumers, business, government, and foreign countries.

What definitely doesn't shift the curve?

•  Changes in price level cause a move along the curve.

Why is AD downward Sloping?

1) Real-Balance Effect

• Higher price levels reduce purchasing power of money, this decreases the quantity of expenditures
• Lower price levels increase purchasing power and increase expenditures
• Ex:) If balance in your bank was $50,000, but inflation erodes purchasing power, you'll likely reduce your spending

2) Interest-Rate Effect

• When price level increases, lenders need to charge higher interest rates to get a real return on their bang
• Higher interests rates discourage consumer spending and business investment

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

Shifters of AD

• GDP = C + Ig + G + Xn
• There are TWO parts to a shift in AD

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 = AD --->
DECREASE in AD = AD <--- 

 Determinants of AD

1) Consumption

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 Indebtness

• 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 <---)

2) Gross Private Investment

Real Interest Rate

• lower real interest rate = more investment (AD shifts --->)
• higher real interest rate = less investment (AD shifts <---)

Expected Returns

• higher expected returns = more investment (AD shifts --->)
• lower expected returns = less investment (AD shifts <---)

Expected Returns are influenced by:

• expectations of future profitability
• technology
• degree of excess capacity
• business taxes

 3) Government Spending

• more government spending (AD shifts --->)
• less government spending (AD shifts <---)

 4) Net Exports

Exchange Rates (International value of $)

• strong $ = more imports and fewer exports (AD shifts <---)
• weak $ = fewer imports and more exports (AD shifts --->)

Relative Income

• strong foreign economies = more exports (AD shifts --->)
• weak foreign economies = less exports (AD shifts <---)