Transcript Aggregate Demand - colin

Macroeconomics
Important Definitions
• National Income
– The total income of all individuals in the economy,
BEFORE taxes are taken out.
• Disposable Income
– The total income of all individuals in the economy,
AFTER taxes are taken out.
• Domestic Product
– Gross National Income = Gross Domestic Product
– GNI = GDP = C + I + G + (X - M) B&B p. 538-9
AD Defined
• Aggregate Demand = Total Spending on goods and
services in a period of time at a given price
• Aggregate Demand = the total amount that all
consumers, business firms and government agencies
spend on final goods and services
• These definitions differ slightly, but the important thing
is what they have in common:
– Total spending on goods & services across an entire
economy.
Graphing AD
• The graph to the right shows
us many things:
– First, the y-axis shows price
level, which means average
prices across the entire
economy.
– Second, the x-axis shows “real
output” which means national
output adjusted for inflation.
– Third, the relationship here is
very simple: as price level falls,
the amount of total real output
demanded increases.
P2
Price
Level
P1
Aggregate
Demand
P2
Q1
Q2
Real Output =
National Income = Y
Components of AD: C+I+G+(X-M)
• Aggregate Demand shows all the spending in a national
economy. Therefore it equals the spending of households, firms
and the government. Imports & Exports represent spending
that either comes into a nation’s economy or leaves it.
• C = Consumer spending on domestic goods & services
– Durable (lasting longer than one year)
– Non-durable goods (used up immediately)
• I = Investment (firms spending capital to maintain production replacement - or to expand production - induced)
• G = Government Spending (everything from schools to law
enforcement to military goods)
• (X - M) = Exports minus imports this gives us the net injection
or leakage from the purchase and sale of goods to foreign or
from foreign nations.
Changes in Price Level
• A change in price level will
result in movement along the
AD curve, from one level of
output to another.
• This is important because it
indicates the connection
between price level and
growth; one way to
encourage growth in the
economy is to reduce price
level
P2
Price
Level
P1
Aggregate
Demand
P2
Q1
Q2
Real Output =
National Income = Y
Changes in AD
• An increase in any of the
components of AD will
result in an increase of
aggregate demand and
shift the curve. From
AD1 to AD 3.
• A Decrease in any of the
components will shift the
curve from AD1 to
AD2.
• Change in Components of AD
Price
Level
AD2
AD1
Real output = Y
AD3
Changes in AD Components:
Consumption
Factors
Income
Explanation
Interest Rates
When interest rates rise, less borrowing occurs and less
consumer spending happens - especially for durable goods.
Falling interest rates lead to increased consumption, c.p.
Wealth
Wealth = assets that people own. As their assets gain in
value, many people are more likely to spend money, leading
to increased aggregate demand.
Consumer
expectations
If people are optimistic about their economic future then
they are likely to spend more now. Economists measure
this as consumer confidence.
In a growing economy where national income is rising,
there will be an increase in consumption, and therefore in
aggregate demand.
Changes in AD Components:
Investment
Factor
Explanation
Interest Rates
Lower rates will lead to greater business investment
because the cost of renting capital decreases, c.p.
Level of
National Income
When national income is rising, people are consuming
more. This means firms will need to invest in
increased capacity to meet greater demand.
Technology
As technology changes firms will need to invest in the
latest machinery in order to stay competitive.
Expectations
Just like consumers, firms base much of their
investment decisions on the expectations of the
economy in the future.
Changes in AD Components:
Exports and Imports
• Exports
– Exports are goods &
services bought by
foreigners.
– If foreign incomes rise,
demand for exports will
also rise.
– If Chinese workers’
income rises, they will buy
more exports from
Europe & the US.
• Imports
– As national income rises,
people spend more on
imported goods.
– As national incomes rise,
investment also tends to
rise.
– If national income falls,
there will be reduced
spending on imports.
Changes in AD Components:
Government Spending
• Monetary Policy
– Monetary policy is
defined as the set of
official policies governing
the supply of money and
the level of interest rates
in an economy.
– Lower interest rates
encourage borrowing by
both consumers and
firms, leading to increased
aggregate demand (c.p.)
• Fiscal Policy
– Fiscal policy is how the
government regulates its own
spending and taxation.
– Taxes can be raised or lowered
to alter the amount of
disposable income that
consumers have.
– Government spending can be
increased or decreased to affect
aggregate demand also.
The Circular Flow from B&B