Unit 3

Aggregate(TOTAL) Demand (AD)

•Shows the amount of real GDP that the private, public and foreign sector collectively desire to purchase price level

Aggregate Demand  (2/11)

•The relationship between the price level and the level of REAL GDP is inverse 

-Three reasons AD is downward sloping

•Real Balances 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

• Interest Rate Effect 

- A higher price level increases the interest rate which tends to discourage investment 

- A lower price level decreases the interest rate which tends to encourage investment 

•Foreign Purchase Effect

- A higher price level increases the demand for relatively cheaper imports

- A Lower price level increases il the foreign demand for relatively cheaper US exports 

•Shifts in Aggregate Demand

• There are two parts to a shift in AD

- a change in C, Ig, G, and/or Xn (expenditure approach to GDP)

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

•increases in AD= AD➡️

•decreases in AD=⬅️

Consumption 

•Household spending is affected by:

 - consumer wealth 

       •more wealth= more spending(AD shift➡️)

       •less wealth= less spending(AD⬅️)

-Consumer expectations 

     •positive expectations=more spending(AD➡️)

      Negative expectations=less spending(AD⬅️)

-Household indebtedness 

   •less debt=more spending(AD➡️)

   •more debt= less spending(AD⬅️) 

-Taxes

     •less taxes=more spending(AD➡️)

      •more Taxes=less spending⬅️

GROSS DOMESTIC Private investment 

•investment spending is sensitive to

    -the Real Interest Rate 

      •lower real interest rate= more investment 

       •higher real interest= less investment 

-Expected Returns

  •higher expected returns: more investment 

  •lower expected returns: less investment 

  • expected returns are influenced by:

       -expectations of future profitability 

       -technology 

       -degree of excess capacity (existing stock of capital) 

Government Spending 

 - more government spending shift right 

 -less government spending AD shift left

•net exports

   •net exports are sensitive to:

       -Exchange Rates(international value of $)

          •strong $= more imports and fewer exports= AD ⬅️

          •weak $= fewer imports and more exports= (AD➡️)

         -Relative Income

            •Strong Foreign Economies= More exports AD➡️

             •Weak foreign economies= less exports AD(⬅️)