Unit 3: 02/12/16

Aggregate Demand Curve (total)

Demand by consumers, businesses, government, and foreign countries. 

What doesn't shift the curve? 

Changes in price level cause a move along the curve.

AD= C+Ig+G+Xn

Why is AD downward sloping? 

1. Real balance effect- Higher price levels reduce the purchasing power of money. - This decreases quantity of expenditures. - Lower price levels increase purchasing power and increase expenditures. 
2. Interest rate effect- When price level increases, lenders need to charge higher interest rates to get a REAL return on their loans. -Higher interest rates discourage consumer spending and business investment. Why? 
3. Foreign trade effect- When US price level rises, foreign buyers purchase fewer US goods and Americans buy more foreign goods.                                                                     -Exports fall and imports rise, causing real GDP to fall (Xn decreases) 

Shifters of aggregate demand 

GDP= C+Ig+G+Xn

*There are two parts to a shift in AD

1. A change in C, I, G, 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 <-

Increase in AD

Decrease in AD

Determinants of AD

1. Consumption

   Consumer Wealth 

• more wealth= more spending AD ->
• less wealth= less spending     AD <-

Consumer Expectations 

• positive expectations = more spending AD shifts ->
• negative expectations = less spending AD shifts <-

Household Indebtedness 

•  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 Domestic Investment

 Investment spending is sensitive to:

 

-The 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 influenced by: 

- Expectations of future probability

-Technology

-Degree of excess capacity (existing stock of capital)

-Business Taxes

3.Government Spending 

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

4. Net exports 

Are sensitive to: 

- Exchange Rate (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 <-