unit 3 aggregated demand

Aggregated demand
-show the amount of real GDP that the private, public, foreign sectors collectively desire
-inverse relationship between price level and real GDP


Left is decrease
Right is increase

3 reason AD is downward sloping
       1.real balance effect

•   when the price level is high households/business cant afford to purchase as much output
• when the price level is low households/business can afford to purchase more output.

       2.interest rate effect

•  the a higher price level increases the interest rate which tends to discourage investment
•  lower price level decreases the interest rate which tends to encourage investment

       3.foreign purchase effect

• a higher price level increases the demand for relatively cheaper imports
• a lower price level increases the demand for relatively cheaper us exports

Shifts in aggregated demand
2 components
-A change in C, Ig , G and Xn
-Multiplier effect that produces a greater change than the original change in the 4 components

• Increase in AD= shifts to the right
• Decrease in AD=shifts to the left

Determinants of AD
    1. Consumption (C)-household spending affected by
                     -consumer wealth

• More wealth: More spending ( shift to the right. -->)
• less wealth: less spending ( shift to the left <--)

                -consumer expectation

• positive expectation: more spending ( shift to the right -->)
• negative expectation: less spending  ( shift to the left <--)

               - Household indebtedness

• less debt: more spending ( shift to the right -->)
• more debt: less spending ( shift to the left <--)

          - Taxes

• less taxes : More spending ( shift to the right -->)
• More taxes : less spending (shift to to the left <--)

    2. Investment spending
        -real interest rate

• Lower real interest rate : more investment ( shift tot the right -->)
• Higher real interest rate : less investment ( shift to the left <--)

       - Expected returns

• Higher expected returns : more investment ( shift to the right -->)
• lower expected returns : less investment ( shift to the left <--)
• Expected returns are influenced by: - expectation of future probability, -technology, degree of excess capacity ( existing stock of capital),- business taxes

3. Government spending

• More government spending :( shift to the right -->)
• less government spending: ( shift to the left <--)

4.Net exports

          - exchange rate( international value of money)

• strong money : more imports and fewer exports ( shift to the left <--)
• weak money: fewer imports and more exports ( shift to the right -->)

           - relative income

• strong foreign economy: more exports ( shift tot he right -->)
• weak foreign economy : less exports ( shift to the left <--)