Unit 3: Aggregate Demand Curve

Definition: AD is the demand by consumers, businesses, government, & foreign countries  

What definitely doesn't shift the curve ?

• Change is in price level cause a move along the curve 
• Formula : AD = C + Ig +G +Xn

Why is AD downwards sloping?

Real-Balance Effect
Definition: Higher price levels reduce the purchasing power of money 

• This decreases quantity of expenditure 
• Lower price levels increases purchasing power and increase expenditures 
• Ex: If the balance in your bank was $50,000, but inflation erodes your purchasing power you will likely reduce your spending  

 Interest Rate Effect 
Definition: When the price level increases, lenders need to change higher interest rates to get real return on their loans.

• Higher interest rates discourage consumer spending and businesses investment. WHY?

Foreign Trade Effect

Definition: When U.S price level rises, foreign buyers purchase fewer U.S fewer U.S good & Americans buy more foreign goods

• Exports fall and imports rise causing Real GDP demanded to fall (Xn decreases) 

Shifters of Aggregate Demand:

• Formula: GDP = C + Ig + G + Xn
• There are two parts to a shift in AD 
• Change in C, Ig, G, and / or Xn  
• Multiplier effect that produces a greater change than the original change in components  
• Increase in AD shifts AD right 
• Decrease in AD shifts AD left  

Determinants of AD :

Consumption:

• Household spending is affected by:
• Consumer Wealth
•  more wealth= more spending ( AD shifts right)
•  less wealth= less spending ( AD shifts left) 

Consumer Expectations

• Positive Expectations= more spending (AD shifts left) 
• Negative Expectations= more spending (AD shifts left) 

Household Indebtedness

• Less Debt = more spending ( AD shifts right )
• More Debt= less spending ( AD shits left) 

Taxes

• Less taxes = more spending (AD shifts right)
• More taxes = less spending (AD shifts left )

Gross Private Investment:

• Investment spending is sensitive to:
• Lower real interest rate = more investment ( AD shifts right)
• Higher real interest rate = less investment (AD shifts left) 
• Expected returns:
• Higher expected returns = more investment ( AD shifts right )
• Lower Expect returns = less investments ( AD shifts left )
• Expected returns are influenced by:
• Expectations of future profitability
• Technology  
• Degree of excess capacity (existing stock of capital)
• Business taxes  

Government Spending:

• More government spending ( AD shifts right)
• Less government spending ( AD shifts left) 

Net Exports:

• Next exports are sensitive to:
• Exchange rates ( international value of $)
• Strong $ = more imports and fewer exports ( AD shifts left) 
• Weak $ = fewer imports and more exports ( AD  shifts right)
• Relative Income:
• Strong foreign economies = more exports  (AD shifts right) 
• Weak Foreign Economies =  less exports ( AD shifts left)