Unit 3 Aggregate Demand

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. 

Three reasons AD is downward sloping. 

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 can afford to purchase more output. 

Interest rate effect

-a higher price level increases the interest rate which tends to discourage investment

-a lower price level decreaes the interest rate which tends to encourage investment

Foreign purchases effect

-a higher price level increases the demand for relatively chaper imports

-a lower price level increases the foreign demand for relatively cheaper US exports

Shifts in Aggregate demand. AD

-There are two parts to a shift in AD

    ■

    ■

Increases in AD equals AD →

 

Consumption

-Household spending is affected by 

 ■consumer wealth

   ● more wealth is more spending →

   ●less wealth is less spending ←

-Consumer expectations

  ● positive expectations is more spending →

  ●negative expectations is less spending ←

-Household indebtedness

   ●less debt is more spending →

   ●more debt is less spending ←

-Taxes

   ● less taxes is more spending →

   ● more taxes is less spending ←

Gross private investment

●Investment spending is sensitive to:

  -The real interest rate

     ○Lower real interest rate is more investment

     ○higher real interest rate is less investment

-Expected Returns

       ○higher expected returns is more investment

       ○lower expected returns is less investments

       ○ expected returns are influenced by expectations of future profitability, technology, degree of excess capacity, business taxes 

  Government spending

-More government spending AD shifts right

-Less government spending AD shifts left

Net Exports are sensitive to:

-Exchange rates (international value of $)

Strong $ is more imports and fewer exports is AD shifting to the left

Weak $ is fewer imports and more exports is AD shifting to right

-Relative Income

Strong foreign economies is more exports is AD shifted to the right

Weak foreign economies is less exports is AD shifted to the left