Unit 3 Aggregate Demand Curve

February 2, 2016

Aggregate Demand Curve

AD is the demand by consumers, businesses, government, and foreign countries.

What definitely doesn’t shift the curve?

Change in price level causes a move along the curve.

AD=C+I+G+XN

1.      Real balance effect-

·           Higher price level reduce the purchasing power of money

·           This decreases the quantity of expenditures

·           Lower price levels increase purchasing power and increase expenditures

Ex. $50,000 in bank account, inflation erodes

2.      Interest-rate effect-

·             When the price level increases, lenders need to change higher interest rates to get a REAL return on their loans

·             Higher interest rates discourage consumer spending and business investment EX. Interest rate increases 5% to 25%

3.         Foreign trade effect-

·             When U.S. price level rises, foreign buyers purchases fewer U.S. goods and Americans buy more foreign goods

·             Exports fall and inputs rise causing real GDP demanded to fall (Xn decreases)

Shifters of Aggregate Demand

GDP= C+Ig+G+Xn

Shifts in AD

1.         A Change in C,Ig,G and / or Xn

2.         Multiplier effect that produces a greater change than original change in 4 components

Increase in AD= AD right

Decrease in AD =AD left

Consumption

·             Household spending is affected by

-consumer wealth

·             More wealth = more spending AD shifts ->

·             less wealth = less spending AD shifts <- o:p="">

-consumer expectations

·             positive expectations = more spending AD shifts  ->

·             negative expectations = more spending AD shifts   <- o:p="">

-household indebtedness

·             less dept = more spending ->

·             more debt = less spending <- o:p="">

-taxes

·             less taxes = more spending AD ->

·             more taxes = less spending AD  <- o:p="">

Gross private investment

Investment is sensitive to:

-Real interest rate

·             lower real interest rate = more investment AD ->

·             higher real interest rate= less investment AD <- o:p="">

·             expected returns are influenced by

-expectations of future probability

-technology

-degree of excess capacity coexisting stock of capitol

-business taxes

-government spending

·             more government spending AD ->

·             less government spending AD <- o:p="">

Net exports

net exports are sensitive to:

                  -exchange rates (international value cf $)

·             strong $ = more imports and fewer exports =AD <- o:p="">

·             weak $ = fewer imports and more exports = AD ->

-relative incomes

·             strong foreign economics= more exports = AD ->

·             weak foreign economics = less exports = AD <- o:p="">