UNIT 3 Intro: Aggregate Demand

(2/18/16)

Aggregate Demand: demand by consumers, businesses, government, and foreign countries.
                               - focus on Price Level and Real GDP.
                               - Changes in price level cause a move along the curve.
                               - AD = C + I + G + Xn

Why is AD Downward Sloping?
1.) 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.
                                       - EX./ inflation erodes purchasing power in $50,000 in bank.

2.) Interest-Rate Effect - When the price level increases, lenders need to change higher interest rates
                                        to get a REAL return on their loans.
                                      - Higher interest rates discourage consumer spending & business investment.
                                      - EX./ Interest rate increases from 5% to 25%, less likely to get loans to
                                        improve business.

3.) Foreign Trade Effect - When U.S price level rises, foreign buyers purchase fewer U.S goods &
                                          Americans buy more foreign goods.
                                        - Exports fall & imports rise causing real GDP demanded to fall.
                                          (Xn decreases)

*Shifters of AD: GDP = C + I + G + Xn

Shifts in AD:
- There are two parts to a shift in AD:
1) A change in C, Ig, G, and/or Xn.
2) A multiplier effect that produces a greater change than the original change in the 4 components.

*Increases in AD = AD ---> (shift right)
*Decreases in AD = AD <--- (shift left)

Determinants of AD:
1.) Consumption: Household spending is affected by...
                             Consumer Wealth:
                             - more wealth = more spending (AD --->)
                             - less wealth = less spending (AD <---)
                             Consumer Expectations:
                             - positive expectations = more spending (AD --->)
                             - negative expectations = less spending (AD <---)
                             Household indebtedness:
                             - less debt = more spending (AD --->)
                             - more debt = less spending (AD <---)
                             Taxes:
                             - less taxes = more spending (AD --->)
                             - more taxes = less spending (AD <---)

2.) Gross Private Investment: Investment spending is sensitive to...
                                                The Real Interest Rate:
                                                - lower = more investment (AD --->)
                                                - higher = less investment (AD <---)
                                                 Expected Returns:
                                                - higher = more investment (AD --->)
                                                - lower = less investment (AD <---)
                                                 Expected Returns influenced by:
                                                - Expectations of future profitability
                                                - Technology
                                                - Business Taxes
                                                - Desire of Excess Capacity (Existing stock of capital)

3.) Government Spending: - More gov. spending (AD --->)
                                            - Less gov. spending (AD <---)

4.) Net Exports: Net Exports are sensitive to...
                           Exchange Rates (International value of $):
                           - strong $ = more imports & fewer exports (AD <---)
                           - weak $ = fewer imports & more exports (AD --->)
                           Relative Income:
                           - strong foreign economics = more exports (AD --->)
                           - weak foreign economics = less exports (AD <---)