Unit III
Aggregate Demand Curve

• AD is the demand by consumers, businesses, government, & foreign countries  
• 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)