Unit 3- Aggregate Demand

Aggregate Demand (AD): The demand by consumers (C), businesses (Ig), government (G), and foreign countries (Xn). 

• Changes in price level (PL) cause a move along the curve, NOT a shift of the curve
• Shows the amount of real GDP(GDPᵣ) that the private, public, and foreign sector collectively desire to purchase at each possible PL.
• The relationship between the PL and the level of GDPᵣ is inverse.
• AD = C + Ig+ G + Xn

3 reasons why AD is downward sloping
1. Wealth Effect

• Higher prices reduce purchasing power of money
• This decreases the quantity of expenditures.
• Lower price levels increase purchasing power and increase expenditures.

2. Interest rate effect

• As price level increases, lenders need to charge higher interest rates to get a REAL return on their loans.
• Higher interest rates discourage consumer spending and business investment.

3. Foreign Trade Effect

• When U.S. price level rises, foreign buyers purchase fewer U.S. goods and Americans buy more foreign goods.
• Exports fall and imports rise causing real GDP demanded to fall (Xn decreases).

Shifts of Aggregate Demand
There are two parts to a shift in AD:

• A change in C, Ig, G, and/or Xn
• A multiplier effect that produces a greater change the original change in the 4 components

Increases in AD = AD→
Decreases in AD = AD←




Determinants of AD
1. Change in Consumer Spending (C)

• Consumer Wealth (Boom in the stock market...)
• Consumer Expectations (People fear a recession...)
• Household Indebtedness (More consumer debt...)
• Taxes (Decrease in income taxes...)

2. Change in Investment Spending (Ig)

• Real Interest Rate (Price of borrowing money)
• (If interest rates increase/decrease...)                             
• Future Business Expectations (High expectations...)      
• Productivity and Technology (New robots...)       
• Business taxes (Higher corporate taxes means...)

3. Change in Government Spending (G)

• (War...)
• (Nationalized Health Care...)
• (Decrease in defense spending...)

More government spending = AD→
Less government spending = AD←

4. Change in Net Exports (X-m)

• Exchange rates(If the US dollar depreciates relative to the euro...)
• National Income Compared to Abroad 
• (If a major importer has a recession..)
• (If the US has a recession...)
• The phrase "If the US gets a cold, Canada gets pneumonia" is a good way to remember this