Aggregate Demand Curve

Aggregate Demand Curve - The demand by consumers, businesses, government and foreign countries.

- Changes in the price level can cause a move along the AD curve, but not a shift

Aggregate Demand (AD) - Shows the amount of real GDP that the private, public and foreign sector collectively desire to purchase at each possible price level.

- Relationship between price level and level of real GDP is INVERSE

3 Reasons Why AD is Downwards Sloping

1. Wealth effect

- Higher prices reduces purchasing power of money

- Decreases quantity of expenditures

- Lower price levels increase purchase power and increase expenditures

2. Interest-Rate Effect

-  As price level increase, lenders need to charge higher interest rates to get a REAL return on loans

- Higher interest rates discourage consumer spending and business investment

3. Foreign Trade Effect

- When U.S price level rises, foreign buyers purchase fewer U.S goods and Americans buy more foreign goods

- Exports fall and imports rise causing real GDP demanded to fall

Shifts in Aggregate Demand

- The 2 parts to a shift in AD are:

1. A change in C,I,G and/or Xn

2. A multiplier effect that produces a greater change than the original change in the 4 components

Determinants of AD

- Consumption (C)

-Gross private investment

- Gov spending

- Net Exports

1. Change in Consumer Spending

- Consumer Wealth (boom in stock market)

- Consumer Expectations (people fear a recession)

- Household indebtedness (more consumer debt)

- Taxes (decease in income taxes)

2. Change in investment spending

- Real interest rates (price of burrowing money)

- Future business expectations (high expectations)

- Productivity and technology (new robots)

3. Changes in gov spending

- War, nationalized healthcare and decrease in spending

4. Change in net exports

- Exchange rates (u.s dollar depreciates relative to the euro)

- National income compared to abroad (if major importer has a recession)