Aggregate Demand (AD)- Shows the amount of Real GDP that the private, public, and foreign sector collectively desire to purchase at each possible price level.
- AD is demand by consumer, business, government, and foreign countries.
- Changes in price level causes a MOVE not a SHIFT
- The relationship between the price level and the level of Real GDP is INVERSE (↑↓,↓↑)
- AD= GDP= C+Ig+G+Xn
3 Reasons why AD is downwards sloping
- Wealth Effect- higher prices reduce purchasing power of $, decreases the quantity of expenditures, lower price levels increase purchasing power. (EX. if the balance in your bank was $50,000, but inflation erodes your purchasing power, you will most likely reduce your spending.) PRICE LEVEL GOES UP, GDP DEMAND GOES DOWN. (↑,↓)
- Interest-Rate Effect- As price level increases, lenders need to charge higher interest rate to get a REAL return on their loans. Higher interest rates discourage consumer spending and business investment. (EX. Increase in price leads to an increase in the interest rate from 5% to 25%. You are less likely to take out loan to improve your business.)
- Foreign Trade Effect- When U.S. price level rises, foreign buyers purchases fewer U.S. goods and American buy more foreign goods. Exports fall and import rises causing real GDP demanded to fall. (Xn Decreases). (EX. If prices triple in the US, Canada will no longer buy US goods causing quantity demanded of US products to fall.)
Shifts in Aggregate Demand
- A change in C, Ig, G, Xn
- A multiplier effect that produces a greater change than the original change in the 4 components.
Decrease in AD= AD ←
Determinants of AD
- Consumption (C)
- Gross Private Investment (Ig)
- Government Spending (G)
- Net Exports (Xn)= Exports-Imports
Consumption (C)
- Consumer Wealth- boom in the stock market...
- Consumer Exception- people fear a recession...
- Household Indebtedness- more consumer debt...
- Taxes- decreases in income taxes...
Gross Private Investment (Ig)
- Real Interest Rate- price of borrowing $...
- Future Business Exceptions- higher exceptions...
- Productivity and Technology- new robots...
- Business Taxes- higher corporate taxes means...
- War
- Nationalized Health Care
- Decreases in defense spending
- Increase in government spending (AD → )
- Decrease in government spending (AD ←)
- Exchange Rate- if the US dollars depreciates relative to the euro
- National Income Compared to Aboard- if a major importer has a recession. If the US had a recession.
- "If the US gets a cold, Canada gets Pneumonia"
