Transcript aggregate-demand curve

EXPLAINING SHORT-RUN
ECONOMIC FLUCTUATIONS
Aggregate Demand and Aggregate
Supply
• Economists use the model of aggregate
demand and aggregate supply to explain
short-run fluctuations in economic activity
around its long-run trend.
Aggregate Demand and Aggregate
Supply
• The aggregate-demand curve shows the
quantity of “Made in USA” goods and
services that households, firms, the
government, and foreigners want to buy at
each price level.
• The aggregate-supply curve shows the
quantity of “Made in USA” goods and
services that US firms would like to
produce and sell at each price level.
Figure 2 Aggregate Demand and Aggregate
Supply...
Price
Level
Aggregate
supply
Equilibrium
price level
Aggregate
demand
0
Equilibrium
output
Quantity of
Output
Figure 3 The Aggregate-Demand Curve is
downward sloping
Price
Level
P
P2
1. A decrease
in the price
level . . .
0
Aggregate
demand
Y
Y2
2. . . . increases the quantity of
goods and services demanded.
Quantity of
Output
Why the Aggregate-Demand Curve Is
Downward Sloping: three reasons
• The Wealth Effect: a lower price level
boosts consumption spending by
households
• The Interest Rate Effect: a lower price
level boosts investment spending by
businesses
• The Exchange-Rate Effect: a lower price
level boosts net exports
Why the Aggregate-Demand Curve Is
Downward Sloping: Wealth Effect
• A decrease in the price level increases the
purchasing power of consumers’ monetary
wealth, which in turn encourages more
consumption.
• Besides, if a price decline is perceived to be
temporary it would make sense to boost
spending quickly, while prices are still low
• This increase in consumer spending means
larger quantities of goods and services
demanded.
Why the Aggregate-Demand Curve Is
Downward Sloping: Interest Rate
Effect
• A lower price level reduces interest rates.
• Lower interest rates encourage greater
investment spending (by businesses).
• This increase in investment spending
means a larger quantity of goods and
services demanded.
Why the Aggregate-Demand Curve Is
Downward Sloping: Exchange-Rate
Effect
• A decrease in the U.S. price level causes U.S.
interest rates to fall
• As a result, the value of the dollar decreases.
• As a result, US goods become cheaper relative
to foreign goods.
• This makes U.S. net exports increase.
• The increase in net export spending means a
larger quantity of goods and services
demanded.
Shifts in the Aggregate Demand
We have seen why the AD
is negatively sloped.
Curve curve
We know why aggregate
But what are the reasons
demand would increase
why the AD curve might
from Y1 to Y2 when the
shift? In other words, what
price level decreases from
are the reasons why
P1 to P2.
aggregate demand might
increase to Y2 even if the
price level stays put at P1?
Price
Level
P1
P2
D2
Aggregate
demand, D1
0
Y1
Y
Y22
Quantity of
Output
Why the Aggregate-Demand Curve
Might Shift
• Shifts arising from
– Consumption: tax rates, prices of assets
(stocks, bonds, real estate)
– Investment: technological progress, business
confidence, tax rates, money supply
– Government Purchases
– Net Exports: foreign GDP, expectations about
exchange rates
AGGREGATE DEMAND
• The four components of GDP (Y)
contribute to the aggregate demand for
goods and services.
Aggregate Demand = C + I + G + NX
• In equilibrium, supply = demand. So,
Y = Aggregate Demand
• Therefore, in equilibrium
Y = C + I + G + NX