Notes (2/11/15) - AGGREGATE DEMAND

• shows the amount of real GDP that the private, public, and foreign sectors collectively desire to purchase at each possible price level
• the relationship between the price level and the level of real GDP is inverse

• Three reasons AD is downward sloping:
• (1) Real-balance effects
• when price-level is high households and businesses cannot afford to purchase as much output
• when price-level is low households and businesses can afford to purchase more output
• (2) Interest-rate effects
• higher price-level increases the interest rate which tends to discourage investment
• lower price-level decreases the interest rate which tends to encourage investment
• (3) Foreign-purchase effect
• higher price-level increases the demand for relatively cheaper imports
• lower price-level increases the foreign demand for relatively cheaper U.S. exports

Shifts In AD

• two parts to a shift in AD:
• (1) change in C, Ig, G, and/or Xn
• (2) multiplier effect that produces a greater change than the original change in the four components
• Increases in AD = AD shifts right
• Decreases in AD = AD shifts left
• Increase:

• Decrease: 

Consumption

• Household spending affected by:
• consumer wealth
• more wealth = more spending (AD shifts right)
• less wealth = less spending (AD shifts left)
• consumer expectation
• positive expectation = more spending (AD shifts right)
• negative expectation = less spending (AD shifts left)
• household indebtedness
• less debt = more spending (AD shifts right)
• more debt = less spending (AD shifts left)
• taxes
• less taxes = more spending (AD shifts right)
• more taxes = less spending (AD shifts left)

Gross Private Domestic Investment

• Investment spending is sensitive to:
• 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 return = more investment (AD shift right)
• lower expected return = less investment (AD shifts left)
• influenced by
• (1) expectations of future probability
• (2) technology
• (3) degree of excess capacity (existing stock of capital)
• (4) business taxes

Government Spending

• More government spending (AD shift right)
• Less government spending (AD shift left)

Net Exports

• sensitive to:
• Exchange rate (international value of %)
• strong $ = more imports & fewer exports (AD shift left)
• weak $ = less imports &more exports (AD shift right)
• Relative income
• strong foreign economies = more exports (AD shift right)
• weal foreign economies = less exports (AD shift left)