Transcript Changes in Aggregate Demand

Lesson 7-1
Aggregate Demand
Getting Started
Potential output is the level of output an
economy can achieve when labor is
employed at its natural level.
Potential output is also called the natural
level of real GDP.
Aggregate Demand
Basic Concepts
There are four sources of demand that firms face:
households (personal consumption), other firms
(investment), government agencies (government
purchases), and foreigners (net exports).
Aggregate demand is the relationship between the total
quantity of goods and services demanded (from all of the
four sources of demand) and the price level, all other
determinants of spending unchanged.
The aggregate demand curve is a graphical
representation of
aggregate demand.
The Slope of the Aggregate Demand Curve
The implicit price deflator is the measure of the price
level used on the aggregate demand curve.
The aggregate demand curve is negatively sloped
but not for the same reasons as the demand curve
for a particular good.
A price level change cannot cause substitution of
cheaper goods as it does in an individual market
because the price level is an average of all prices.
A reduction in the average price level is unlikely to
generate an increase in real income that induces
more purchases, as a single price decline does in an
individual market, because the incomes people
receive are likely to fall with other prices.
The aggregate demand curve slopes downward for three
reasons.
The wealth effect is the tendency for a change in the price
level to affect real wealth and thus alter consumption.
The interest rate effect is the tendency for a change in the
price level to affect the interest rate and thus to affect
investment demand.
The international trade effect is the tendency for a
change in the price level to affect net exports.
A change in the price level generally results in a change in
the aggregate quantity of goods and services demanded,
that is, a movement along the aggregate demand curve.
Changes in Aggregate Demand
Aggregate demand changes in response to a
change in any of its components.
A change in aggregate demand is a change in
the aggregate quantity of goods and services
demanded at every price.
A change in aggregate demand is shown
graphically as a shift in the aggregate demand
curve.
Causes of change in Aggregate Demand
Changes in Consumption
Changes in tax policy
Changes in Investment
Changes in interest rates
Changes in Government Purchases
Changes in foreign incomes
Changes in foreign price levels
Changes in consumer confidence
Changes in transfer policy
Expectations of firm managers
Changes in tax policy
Changes in Net Exports
Changes in exchange rates
Changes in trade policies
The Multiplier
Any initial change in spending from any component
of GDP generates new income that increases
consumption spending.
The ultimate change in income is larger than the
initial change in spending from any component of
GDP.
The multiplier is the ratio of the change in the
quantity of real GDP demanded at each price level
to the initial change in one or more components of
aggregate demand that produced it.