02/19/14 Aggregate Demand

• Aggregate Demand (AD)
• Shows the amount of real GDP that the private, public, and foreign sector collectively desire to purchase at each purchase price level. 
• The relationship between the price level and the level of real GDP is inverse.
• Aggregate Demand Curve

• Three reasons AD is downward sloping
1. Real- Balances Effect
• When the price level is high households and businesses cannot afford to purchase as much output.
• When the price- level is low households and businesses cannot afford to purchase more output.
2. Interest- Rate Effect
• A higher price level increases the interest rate which tends to discourage investment.
• A lower price level decreases in interest rate which tends to encourage investment.
3. Foreign Purchases Effect
• A higher price level increases the demand for relatively cheaper imports.
• In lower price level increases the foreign demand for relatively cheaper U.S exports.
• Shifts in the Aggregate Demand (AD)
• Two parts of a shirt in AD changes in C, Ig, G, and/or Xn.
• A multiplier effect that produces a greater change than the original change in the four components.
• Increases in AD=AD -->
• Decreases in AD= AD <---
• Consumption
1. Household spending is affected by:
• Consumer wealth
• More wealth= more spending (AD shifts -->)
• Less wealth= less spending (AD shifts <--)
2. Consumer expectations
• Positive expectations= more spending (AD shifts -->)
• Negative expectations= less s[ending (AD shifts <--)
3. Household indebtedness
• less debt= more spending (AD shifts -->)
• more debt= less spending (AP shifts <--)
4. Taxes
• less taxes= more spending (AD shifts -->)
• more taxes= less spending (AD shifts <--)
• Gross Private Investment
• Investment spending is sensitive to:
1. The real interest rate
• Lower real interest rate= more investment (AD -->)
• Higher real interest rate= less investment (AD <--)
2. Expected Returns
• Higher expected returns= more investment (AD -->)
• Low expected returns= less investment (AD <--)
• Expected returns are influenced by 
1. Expectations of future profitability
2. Technology
3. Degree of excess capacity (existing stock of capital)
4. Business taxes
• Government Spending
• More government spending, AD increases (AD -->)
• Less government spending, AD decreases (AD <--)
• Net Exports
• Net exports are sensitive to
• Exchange rates (International value of $1)
• Strong $= more imports and fewer exports= (AD <--)
• Weak $= fewer imports and more exports= (AD -->)
• Relative Income
• Strong foreign economies= more exports- (AD -->)
• Weak foreign economies= less exports (AD <--)