Aggregate Demand (AD)

Aggregate demand (AD): shows the amount of real GDP that the private, public and foreign sector collectively desire to purchase in each possible price level
-the relationship between the price level and the level of real GDP is inverse

3 reasons AD is downward sloping

1. Real balanced 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

2. Interest rate effect

-a higher price level increased the interest rate which tends to discourage investment

-a lower price level decreased the interest rate which tends to encourage investment

3. Foreign purchases effect

-a higher price level increased the demand for relatively cheaper imports

-a lower price level increases the foreign demand got relatively cheaper U.S exports

Shifts in aggregate demand (AD)

There are two parts to a shift in AD:

1. a change in C, Ig, G, and/or Xn

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

-increase in AD, AD shifts right

-decrease in AD, AD shifts left

Determinants of AD:

1. 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 right)

  -negative expectations = less spending (AD shifts left)

-Household indebtedness

  -less debt = more spending (AD shifts right)

  -more debt = less spending (AD shifts left)

  -less taxes = more spending (AD shifts right)

  -more taxes = less spending (AD shifts left)

2. Gross private investment 

investment spending is sensitive to:

-The real interest rate

  -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 expected returns = less investment (AD shifts left)

-expected returns are influenced by 

  -expectations of future profitability

  -technology

  -degree of excess capacity (existing stock of capital)

  -business taxes

3. Government spending 

-more government spending (AD shifts right)

-less government spending (AD shifts left)

4. Net exports

net exports are sensitive to:

-exchange rate (int'l value of $1)

  -strong $- more imports and fewer exports (AD goes left)

  -weak $- fewer imports and more exports (AD goes right)

-relative income 

  -strong foreign economies = more exports (AD shifts right)

  -weak foreign economies - less exports (AD shifts left)