Unit III (Aggregate Demand Curve)

-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 

-AD = C + Ig +G +Xn

Why is AD downwards sloping?

• Real-Balance Effect: 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 : 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:When U.S price level rises, foreign buyer's 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:

-GDP = C + Ig + G + Xn

-There are 2 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) 

• 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)