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Learn about Aggregate Demand (AD) in fiscal policy, its relationship to price levels, Real GDP, and the various factors that can shift the AD curve. Understand the Real-Balance Effect, Interest-Rate Effect, and Foreign Trade Effect on AD, as well as the impact of consumer behavior, government spending, investments, and net exports.
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Demand Aggregate Demand Consumer Spending Business Spending Government Spending Aggregate Demand
Aggregate Demand Aggregate means “added all together.” Aggregate Demand = all the goods and services that buyers are willing and able to purchase at different price levels. Price Level Price Level (Inflation), then real GDP demanded Price Level (deflation), the real GDP demanded There is an inverse relationship between price level and Real GDP. AD Real domestic output (GDPR)
Aggregate Demand Curve AD is the demand by consumers, businesses, government, and foreign countries Price Level What definitely doesn’t shift the curve? CHANGES IN PRICE LEVEL!!! AD = C + I + G + Xn Real domestic output (GDPR)
AD Downward Sloping Real-Balance Effect: • Higher price levels reduces the purchasing power of money • Lower price levels increases purchasing power and increase expenditures Example: If the balance in your bank was $50,000, but inflation erodes your purchasing power, you will likely reduce your spending. Price Level Why is AD downward sloping? AD GDP
AD Downward Sloping Real-Balance Effect: • Higher price levels reduces the purchasing power of money • Lower price levels increases purchasing power and increase expenditures Price Level Interest-Rate Effect: If price level increases, lenders charge higher interest rates to get a REAL return on their loans.Higher interest rates discourage consumer spending and business investment. WHY? An increase in prices leads to an increase in the interest rate from 5% to 25%. You are less likely to take out loans to improve your business, so GDP Decreases Why is AD downward sloping? AD GDP
AD Downward Sloping Real-Balance Effect: • Higher price levels reduces the purchasing power of money • Lower price levels increases purchasing power and increase expenditures Price Level Why is AD downward sloping? Interest-Rate Effect: If price level increases, lenders charge higher interest rates to get a REAL return on their loans. Foreign Trade Effect: If 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. (XN Decreases) Example: If prices triple in the US, Canada will no longer buy US goods causing quantity demanded of US products to fall. AD GDP
Shifts in Aggregate Demand An increase in spending shift AD right, and decrease in spending shifts it left Price Level What is this? GDP AD1 AD = C + I + G + Xn AD2 Real domestic output (GDPR)
Shifters of Aggregate Demand Consumers Government Investment Net Export
Shifters of Aggregate Demand Consumers Investment Government Net Exports Consumer Wealth(Boom in the stock market…) Consumer Expectations (People fear a recession…) Household Indebtedness (More consumer debt…) Taxes (Decrease in income taxes…) Ex: Buying Chocolate Milk at the store.
Shifters of Aggregate Demand Consumers Investment Government Net Exports • Consumer Wealth • Consumer Expectations • Household Indebtedness • Taxes Real Interest Rates (If interest rates increase…) (If interest rates decrease…) Future Business Expectations (High expectations…) Business Taxes (Higher corporate taxes means…) Ex: Buying Chocolate Milk at the store. Ex: Nestle buys a new factory.
Shifters of Aggregate Demand Consumers Investments Government Net Exports • Consumer Wealth • Consumer Expectations • Household Indebtedness • Taxes • Real Interest Rates • Future Business Expectations • Business Taxes • War • Nationalized Health Care • Decrease in defense spending Ex: Buying Chocolate Milk at the store. This is also known as discretionary spending. Ex: Nestle buys a new factory.
Shifters of Aggregate Demand Consumers Net Exports Government Investments • War • Nationalized Health Care • Decrease in defense spending Change in Net Exports (X-N)Exchange Rates (If the us dollar depreciates relative to the euro…) National Income Compared to Abroad (If a major importer has a recession…) (If the US has a recession…) • Consumer Wealth • Consumer Expectations • Household Indebtedness • Taxes This is also known as discretionary spending. • Real Interest Rates • Future Business Expectations • Business Taxes The number of Fords exported to China minus the number of Chery Imports from China. Ex: Nestle buys a new factory. Ex: Buying Chocolate Milk at the store.
