-Unit 3- �National Income and Price Determination

Aggregate Demand

Module 17

Pages 172-178

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McConnell

Chapter 29

Demand and Supply Review

• Define Demand and the Law of Demand.
• Why is demand downward sloping?
• Identify the difference between a change in demand and a change in quantity demanded.
• Identify the Shifters of Demand.
• Define Supply and the Law of Supply.
• Why is supply upward sloping?
• Identify the Shifters of Supply.
• Name your favorite & least favorite holiday.

Demand

Aggregate Demand

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Aggregate means “added all together.”

When we use aggregates

we combine all prices and all quantities.

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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 U.S.

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.

What is Aggregate Demand?

Aggregate Demand Curve

Price

Level

Real Domestic Output (GDP_R)

AD

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

What definitely doesn’t shift the curve?

Changes in price level cause a move along the curve

= C + I + G + Xn

Remember…

• We use Real GDP to measure Aggregate Output and will often use the two terms interchangeably.
• The Aggregate Demand Curve illustrates the relationship between the Aggregate Price Level (measured by the GDP Deflator) and the Quantity of Aggregate Output demanded in the economy.

Why is AD Downward Sloping?

• Wealth Effect or 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.

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2. Interest-Rate Effect

• When the price level increases, lenders need to charge higher interest rates to get a REAL return on their loans.

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• Higher interest rates discourage consumer spending and business investment. WHY?

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• 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.

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• Result...Price Level goes up, GDP demanded goes down (and Vice Versa).

Why is AD Downward Sloping?

Why is AD Downward Sloping?

3. Net Export Effect or Foreign Trade Effect

• When U.S. price level rises, foreign buyers purchase fewer U.S. goods and Americans buy more foreign goods

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• Exports fall and imports rise causing real GDP demanded to fall. (X_N Decreases)

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• Example: If prices triple in the US, Canada will no longer buy US goods causing quantity demanded of US products to fall.

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• Again, Price Level goes up, GDP demanded goes down (and Vice Versa).

Why is AD Downward Sloping?

Shifters of Aggregate Demand

GDP = C + I + G + X_n

Shifts in Aggregate Demand

Price

Level

Real Domestic Output (GDP_R)

AD

An increase in spending shift AD right, and decrease in spending shifts it left

= C + I + G + Xn

AD₁

AD₂

Shifters of Aggregate Demand

• 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…)

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2. Change in Investment Spending

Real Interest Rates (Price of borrowing $)

(If interest rates increase…)

(If interest rates decrease…)

Future Business Expectations (High expectations…)

Technology (Purchase of new robots…)

Business Taxes (Higher corporate taxes means…)

Shifters of Aggregate Demand

• Change in Government Spending

(War…)

(Nationalized Health Care…)

(Decrease in defense spending…)

• Change in Net Exports (X-M)

Exchange Rates

(If the U.S. Dollar depreciates relative to the Euro…)

National Income Compared to Abroad

(If a major importer has a recession…)

(If the U.S. has a recession…)

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“If the U.S. get a cold, Canada gets Pneumonia”

AD = GDP = C + I + G + X_n

Change in Government Spending Con’t

• Government Spending (G)
• Fiscal Policy
• Change in personal taxes
• Changes in government spending
• Monetary Policy (FED)
• Change in interest rates
• Change in stock of money (MS = Money Supply)

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Fiscal Policy

• Congress and the President control Fiscal Policy.
• It is the use of government spending or tax policy to stabilize the economy.

Monetary Policy

• The Federal Reserve controls Monetary Policy-
• The use of changes in the quantity of money or the interest rate to stabilize the economy.

Change in Net Exports Con’t

• Net Export Spending (Xn)
• International –

Exports v. Imports

• Change in imports
• Change in exports
• Change in tariff policies
• Exchange rates (appreciated v. depreciated $)

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How does this cartoon relate to Aggregate Demand?

How Does This Cartoon Relate to Aggregate Demand?

Krugman’s Shifts in Aggregate Demand-�pg 176

• Changes in Expectations

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• Changes in Wealth

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• Size of the Existing Stock of Physical Capital-or page 552 McConnell

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• Government Policies and Aggregate Demand

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Practice Worksheet-Aggregate Demand & Supply-Introducing Aggregate Demand