Unit 3 AD

Unit 3: Aggregate Demand 

What is Aggregate Demand?

Aggregate means “added all together.” 
When we use aggregates we combine all prices and all quantities. 
Aggregate Demand is all the goods and services (real GDP) that buyers are willing and able to purchase at different price levels. 
The Demand for everything by everyone in the US. 
There is an inverse relationship between price level and Real GDP. If the price level
: •Increases (Inflation), then real GDP demanded falls.
 •Decreases (deflation), the real GDP demanded increases

Aggregate Demand Curve

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

Changes in price level cause a move along the curve 


Why is AD downward sloping? 

1. Real-Balance Effect- • Higher price levels reduce the purchasing power of money • This decreases the quantity of expenditures • Lower price levels increase purchasing power and increase expenditures 
Example: • If the balance in your bank was $50,000, but inflation erodes your purchasing power, you will likely reduce your spending. • So…Price Level goes up, GDP demanded goes down. 


2. Interest-Rate Effect • When the 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? • Example: An increase in prices leads to an increase in the interest rate from 5% to 25%. You are less likely to take out loans to improve your business. • Result…Price Level goes up, GDP demanded goes down (and Vice Versa). 

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)
 • Example: If prices triple in the US, Canada will no longer buy US goods causing quantity demanded of US products to fall. 
• Again, Price Level goes up, GDP demanded goes down (and Vice Versa). 


Shifters of Aggregate Demand GDP = C + I + G + Xn

Shifters of Aggregate Demand 
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 interest rates decrease…) Future Business Expectations (High expectations…) Productivity and Technology (New robots…) Business Taxes (Higher corporate taxes means…) 

3. Change in Government Spending (War…) (Nationalized Heath Care…) (Decrease in defense spending…) 


4. Change in Net Exports (X-M) Exchange Rates (If the us dollar depreciates relative to the euro…) National Income Compared to Abroad (If a major importer has a recession…) (If the US has a recession…)