Transcript Aggregate Demand and Supply

Aggregate Demand
Chapter 11—one week
Aggregate Demand

Aggregate demand is NOT demand
(reminder: single product—P and Q--the
curve is downward sloping because
people will demand more at a lower price)
Is a schedule that shows the amounts of
real domestic output, GDP and Price Level
 Example on page 204, figure 11.1
 Shows an inverse relationship between
price level and domestic output
 The explanation of the inverse relationship
is not the same as for demand for a single
product

 Substitution
effect doesn’t apply in the
aggregate case, since there is no substitute
for “everything”
Explanation of Inverse Relationship

Real Balance Effect or Wealth Effect
 As
the price level falls, cash balances will buy
more so people will spend more, thus
increasing real output.

Interest-Rate Effect
 Decrease
in plans to buy capital and durables
because a PL increase will decrease the
interest rate.
 A PL increase decreases the purchasing
power of $
 A decline in PL means lower interest rates
which can increase levels of certain types of
spending (Ig)

Foreign Purchases Effect or Net Export
Effect

when price level falls, other things being
equal, US prices will fall relative to foreign
prices, which will tend to increase spending
on US exports and also decrease import
spending in favor of US products that
compete with imports
Determinants of A.D.

The “other things” (besides price level)
that can cause a shift or change in
demand (see page 206)

1. Changes in consumer spending (C),
which can be caused by:
Consumer wealth – “Wealth Effect” of
income (liquidity, inflation and “real” income
 B. Future expectations of wages and wealth
 C. Levels of indebtedness and response to
more purchases
 D. Net income after tax payments
 A.

2. Changes in investment spending (Ig),
which can be caused by:
 A.
Interest rates or the cost of borrowing
 B. Future profit expectations
 C. Profit after taxes
 D. Available technology and time to adjust to
technology
 E. Amount of unused capital

3. Change in gov’t spending (G)
 Spending

on G and S
4. Changes in net exports (Xn) unrelated
to PL, which may be caused by:
 Income
abroad
 Exchange rates

Depreciation of the dollar encourages US exports
 and discourages import buying
What shifts the A.D. Curve?
PL
AD2
AD
AD3
Real GDP

Determine whether each situation will
cause an increase, decrease or no change
in AD. Always start with AD. If the
situation would cause an increase in AD,
draw an  in column 1. If there is a
decrease in AD, draw a . If there is no
change, write NC. For each situation that
causes a change in AD, write the number
of the new demand curve in column 2.
Move only one curve.
Situation
1. Congress cuts taxes
2. Gov’t spending to increase next
year; president promises no
increase in taxes
3. Survey shows consumer
confidence jumps
4. Stock market collapses;
investors lose billions
5. Productivity rises for the 4th year
6. President cuts defense
spending by 20%; no increase in
domestic spending
change in AD↑ ↓
Determinate
Situation
change in AD
Determinate
↑
↑
G
G
3. Survey shows consumer
confidence jumps
↑
C
4. Stock market collapses;
investors lose billions
↓
C
NC
↓
G
1. Congress cuts taxes
2. Gov’t spending to increase next
year; president promises no
increase in taxes
5. Productivity rises for the 4th year
6. President cuts defense
spending by 20%; no increase in
domestic spending