Aggregate Demand

Aggregate Demand
-Aggregate Demand (AD): shows amount of real GDP that the private, public, foreign sector collectively desire to purchase at each possible price level

• inverse relationship between price level and real GDP

-Slopes Downward because:

• Real-Balances Effect: 

             *Price levels high: households and businesses CAN'T afford to purchase as much output
             *Price level low: households and businesses CAN afford to purchase more output

• Interest-Rate Effect:

             *Higher price level: increases interest rate; discourages investment
             *Lower price level: decreases interest rate; encourages investment

• Foreign Purchases Effect: 

             *Higher price level: increases demand for relatively cheaper foreign imports
             *Lower price level: increases foreign demand for relatively cheaper U.S. exports

-Shifts in Aggregate Demand:

• 2 Parts

             1) Change in C, Ig, G, and Xn (Components used to determine GDP)
             2) Multiplier effect that produces a greater change than the original change in 4 components

• increase in AD- Graph shifts to the right ->
• decrease in AD- Graph shifts to the left  <-

-Determinants (4):
      1. Consumption (c)- households spending affected by:
            *Consumer wealth
                     -MORE wealth = MORE spending (shifts right)
                     -LESS wealth = LESS spending (shifts left)
            *Consumer expectations
                     -Positive expectations = MORE spending (shifts right)
                     -Negative expectations = LESS spending (shifts left)
            *Household Indebtedness
                     -LESS debt = MORE spending (shifts right)
                     -MORE debt = LESS spending (shifts left)
            *Taxes
                     -LESS taxes = MORE spending (shifts right)
                     -MORE taxes = LESS spending (shifts left)
      2. Gross Private Investment (Ig)- investment spending is sensitive to:
            *Real Interest Rate
                     -LOWER real interest rate = MORE investment (shifts right)
                     -HIGHER real interest rate = LESS investment (shifts left)
            *Expected Returns
                     -HIGHER expected returns = MORE investments (shifts right)
                     -LOWER expected returns = LESS investments (shifts left)
                     -Expected returns influenced by:
                              *Expectations of future profitability
                              *Technology
                              *Degree of Excess Capacity (Existing Stock of Capital)
                              *Business taxes
       3. Government Spending (G)
             *MORE Government spending (AD increases; Shifts right)
             *LESS Government spending (AD decreases; Shifts left)
       4. Net Exports (Xn)- Sensitive to:
             *Exchange rates (International value of the dollar)
                      -Strong $ = MORE imports FEWER exports = AD <- (shifts left)
                      -Weak $ = FEWER imports and MORE exports = AD -> (shifts right)
             *Relative Income
                      -Strong Foreign Economies = MORE exports = AD -> (shifts right)
                      -Weak Foreign Economies = LESS exports = AD <- (shifts left)