2/15/17: Aggregate Demand

• Aggregate Demand Curve
• AD is the demand by consumers, businesses, government, and foreign countries.
• 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 & foreign sector collectively desire to purchase at each possible price level.
• The relationship between the price level & the level of real GDP is inverse (one decreases, other increases.)

1. 3 Reasons why AD is downward sloping
1. Wealth Effect
• Higher prices reduce purchasing power of $
• This decreases the quantity of expenditures
• Lower price levels increase purchasing power & increase expenditures
• Price level goes up, GDP demand goes down
• Ex) If balance in your bank is $50,000, but inflation erodes your purchasing power you will likely reduce your spending 

               2. 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 & business investment.
• Price level goes up, GDP down (& vice versa)
• Ex) Increase in price leads to an increase in the interest rate from 5% to 25%. You are less likely to take out loans to improve your business. 

               3. Foreign Trade Effect

• When U.S price level rises, foreign buyers purchase fewer U.S goods & Americans buy more foreign goods.
• Exports fall & 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.

• Shifts in Aggregate Demand 
• There are two parts to a shift in AD
• A chance in C, Ig, G, and Xn
• A multiplier effect that produces a greater change than the original change in the 4 components.
• Increases in AD = AD shift to the right
• Decreases in AD = AD shift to the left

• Determinants of AD
• Consumption (C)
• Gross private domestic income (Ig)
• Government purchases (G)
• Net exports (Xn)

1. Change in Consumer Spending
• Consumer wealth (boom in the stock market)
• Consumer expectations (people fear a recession)
• Household indebtedness (more consumer debt)
• Taxes (decrease in income taxes)
2. Change in Investment Spending
• Real interest rates (price of borrowing $)
• If interest rates increase..
• If interests rates decrease..
• Future business expectations (high expectations..)
• Productivity & technology (new robots)
• Business taxes
3. Change in Government Spending
• War
• Nationalized health care
• Decrease in defense spending
4. Change in Net Exports
• Exchange rates (if the U.S dollar depreciates relative to the euro)
• National income compare to abroad
• If a major importer has a recession
• If the U.S has a recession
• "If the U.S gets a cold, Canada gets pneumonia" 

• AD = GDP = C + Ig + G + Xn
• Government Spending
• More government spending = AD shift to right
• Less government spending = AD shift to right