Aggregate Demand

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Aggregate Demand

• Macroeconomics
• Ms. Flora

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Overview of Aggregate Demand and Aggregate Supply
Model

• The aggregate demand and aggregate supply model,
  where the price level and output are determined,
  is the central model for macroeconomic analysis.

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AD/AS Model

• This model helps us distinguish between different
  types of short-run economic fluctuations like
  demand shocks and supply shocks.

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Aggregate Demand (AD)

• Shows the relationship between the aggregate
  price level and the quantity of aggregate output
  demanded by households, firms, the government,
  and the rest of the world. C I G XN
• Notice that three of the four variable are
  private-sector decisions
• The relationship between the price level and the
  level of Real GDP is inverse
• See graph ?

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Aggregate Demand Curve

PL
AD
GDPR
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Difference Between the Law of Demand for a
Single Product and theAggregate Demand Curve

• The main reason why the quantity of a good
  demanded falls when the price of that good rises
  is that people switch their consumption to other
  cheaper goods and services
• When we consider movements up and down the AD
  curve, were considering a simultaneous change in
  the prices of all final goods and services.

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Why is the AD Curve Downward sloping?

• There are three main reasons (page 194 MB)
• The Wealth Effect
• The Interest Rate Effect
• Foreign Purchases Effect

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The Wealth Effect(Also called the Real-Balances
Effect)

• An increase in the aggregate price level, other
  things equal, reduces the purchasing power of
  many consumer financial assets (i.e. savings
  accounts or bond holdings).
• Example Someone has 5,000 in a bank account.
  If the aggregate price level were to rise by 25,
  that 5,000 would buy only as much as 4000 would
  have bought previously

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The Interest Rate Effect

• When the aggregate price level goes up, people
  need more money (cash) to buy goods and services.
  This increases the demand for money and causes
  the interest rate to increase.
• Higher interest rates curtail investment spending
  and interest-sensitive consumer spending.

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Foreign Purchases Effect

• A higher price-level increases the demand for
  relatively cheaper imports
• A lower price-level increases the foreign demand
  for relatively cheaper U.S. exports

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Remember

• A change in the price level will change the
  amount of aggregate spending and therefore change
  the amount of real GDP demanded by the economy.
• A change in one of the determinants of aggregate
  demand will cause the entire curve to shift.

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Shifts in Aggregate Demand (AD)

• There are two parts to a shift in AD
• An autonomous change in aggregate spending occurs
  (C, IG, G and/or XN)
• A multiplier effect that produces a greater
  change than the original change in the 4
  components
• Increases in AD AD ?
• Decreases in AD AD ?

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What do we mean by autonomous change in
aggregate spending?

• An initial rise or fall in aggregate spending at
  a given level of GDP is called an autonomous
  change in aggregate spending.
• Its autonomous which means self-governing -
  because its the cause, not the result, of the
  chain reaction known as the multiplier effect.

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Increase in Aggregate Demand

PL
Initial increase in autonomous spending
Multiplier Effect
AD
AD1
AD2
GDPR
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Decrease in Aggregate Demand

PL
Initial decrease in autonomous spending
Multiplier Effect
AD
AD1
AD2
GDPR
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Determinants of AD

• Consumption (C)
• Gross Private Investment (IG)
• Government Spending (G)
• Net Exports (XN) Exports - Imports (X M)

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Consumption

• Household spending is affected by
• Consumer wealth
• More wealth more spending (AD shifts ?)
• Less wealth less spending (AD shifts ?)
• Consumer expectations
• Positive expectations more spending (AD shifts
  ?)
• Negative expectations less spending (AD shifts
  ?)
• Household indebtedness
• Less debt more spending (AD shifts ?)
• More debt less spending (AD shifts ?)
• Taxes
• Less taxes more spending (AD shifts ?)
• More taxes less spending (AD shifts ?)

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Gross Private Investment

• Investment Spending is sensitive to
• The Real Interest Rate
• Lower Real Interest Rate More Investment (AD?)
• Higher Real Interest Rate Less Investment (AD?)
• Expected Returns
• Higher Expected Returns More Investment (AD?)
• Lower Expected Returns Less Investment (AD?)
• Expected Returns are influenced by
• Expectations of future profitability
• Technology
• Degree of Excess Capacity (Existing Stock of
  Capital)
• Business Taxes

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Government Spending

• More Government Spending (AD?)
• Less Government Spending (AD?)

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Net Exports

• Net Exports are sensitive to
• Exchange Rates (International value of )
• 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 ?)

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Summary

• AD reflects an inverse relationship between PL
  and GDPR
• ? in PL creates real-balance, interest-rate, and
  foreign purchase effects that explain ADs
  downward slope
• ? in C, IG, G, and/or XN cause ? in GDPR because
  they ? AD.
• Increase in AD AD ?
• Decrease in AD AD ?