Transcript WELFARE ANALYSIS - Shaler Area School District

AGGREGATE DEMAND
With Mrs. Eskra 
OBJECTIVES:
What will you learn?
• What Aggregate Demand is and what it
looks like.
• Three reasons AD slopes downward:
– Wealth Effect
– Interest Rate Effect
– Exchange Rate Effect
AS/AD Model
The x-axis represents
quantity as in
microeconomics, but
OVERALL quantity in an
economy (real GDP).
The y-axis represents the
overall price level, not just
price of specific item.
This is the most common graph
that shows overall
(macroeconomic) activity.
AGGREGATE DEMAND (AD)
Total amount of goods and services
demanded in an economy at a
specific point in time and at a
prevailing price level.
Aggregate Demand
Aggregate Demand
Downward-sloping curve
Inverse relationship
between price level and
real GDP.
This implies that people (consumers, firms, governments,
and net foreign purchases of U.S. goods) will want to
purchase more as the overall price level falls.
Why??? There are 3 reasons…
Aggregate Demand:
Wealth Effect
As prices fall, people
feel like they are
wealthier.
Because their money
can go further, people
will tend to buy more
(C ↑)
AD = C + I + G + (X-M)
WEALTH EFFECT
Perception that wealth has increased,
resulting in an increase in
consumption, C.
Aggregate Demand:
Interest Rate Effect
As prices fall, this increases
the amount of money
circulating, which drives
down interest rates.
AD = C + I + G + (X-M)
People will buy more items
that require loans, like cars,
houses, appliances, and
furniture – durable goods
(C ↑).
Businesses will also take
advantage of lower rates
and invest in their
companies (I ↑).
INTEREST RATE EFFECT
As interest rates fall, consumption
increases due to the decrease in the
cost of borrowing; as a result,
purchases and business investment
(Consumption, C and Investment, I,
respectively) both increase.
Aggregate Demand:
Exchange Rate Effect
As prices in the U.S. fall, our
goods become relatively
cheaper to foreigners
(exchange rate falls).
Foreigners buy more from
us (X↑), and we buy less
from other countries (M↓).
AD = C + I + G + (X-M)
EXCHANGE RATE EFFECT
Exchange rate movements impact
demand; domestic currency
depreciation increases the cost of
imports, resulting in a potential
decrease in imports, M; the lower
domestic exchange rate increases
foreign demand for domestic goods,
increasing exports, X.
RECAP:
What did you learn?
• What Aggregate Demand is and what it
looks like.
• Three reasons AD slopes downward:
– Wealth Effect
– Interest Rate Effect
– Exchange Rate Effect