Aggregate Demand Notes

-Aggregate(TOTAL) Demand (AD)

•Shows the amount of real GDP that the private, public and foreign sector collectively desire to purchase price level

•The relationship between the price level and the level of REAL GDP is inverse 

-Three reasons AD is downward sloping

•Real Balances Effect

- When the price level is high households and businesses cannot afford to purchase as much output 

- When the price level is low households and businesses can afford to purchase more output

• Interest Rate Effect 

- A higher price level increases the interest rate which tends to discourage investment 

- A lower price level decreases the interest rate which tends to encourage investment 

•Foreign Purchase Effect

- A higher price level increases the demand for relatively cheaper imports

- A Lower price level increases il the foreign demand for relatively cheaper US exports 

•Shifts in Aggregate Demand

• There are two parts to a shift in AD

- a change in C, Ig, G, and/or Xn (expenditure approach to GDP)

- a multiplier effect that produces a greater change than the original change in the 4 components

•increases in AD= AD➡️

•decreases in AD=⬅️

•Consumption 

•Household spending is affected by:

 - consumer wealth 

       •more wealth= more spending(AD shift➡️)

       •less wealth= less spending(AD⬅️)

-Consumer expectations 

     •positive expectations=more spending(AD➡️)

•  negative expectations=less spending(AD⬅️)

-Household indebtedness 

   •less debt=more spending(AD➡️)

   •more debt= less spending(AD⬅️) 

-Taxes

     •less taxes=more spending(AD➡️)

      •more Taxes=less spending⬅️

GROSS DOMESTIC Private investment 

•investment spending is sensitive to

    -the Real Interest Rate 

      •lower real interest rate= more investment 

       •higher real interest= less investment 

-Expected Returns

  •higher expected returns: more investment 

  •lower expected returns: less investment 

  • expected returns are influenced by:

       -expectations of future profitability 

       -technology 

       -degree of excess capacity (existing stock of capital) 

•Government Spending 

 - more government spending shift right 

 -less government spending AD shift left

•Net Exports

   •net exports are sensitive to:

       -Exchange Rates(international value of $)

          •strong $= more imports and fewer exports= AD ⬅️

          •weak $= fewer imports and more exports= (AD➡️)

         -Relative Income

            •Strong Foreign Economies= More exports AD➡️

             •Weak foreign economies= less exports AD(⬅️)