Download Worksheet 17.1: Intro to AD

Worksheet 17.1: Intro to AD
After watching Jason Welker’s “An Introduction to Aggregate Demand” video found at
https://www.youtube.com/watch?v=adgqvtlUtMk, answer the following questions.
1. What factors cause a change in AD?
2. What does household wealth refer to?
3. What determines the level of government spending?
4. How do exchange rates impact AD?
© 2015, BFW/ Worth Publishers
Krugman’s Economics for AP®, 2e
Section 4
Teacher’s Resource Materials
Copyrighted Material - Do Not Post Answers Online
Worksheet 17.1: Intro to AD
Answer Key
After watching Jason Welker’s “An Introduction to Aggregate Demand” video found at
https://www.youtube.com/watch?v=adgqvtlUtMk, answer the following questions.
1) What factors cause a change in AD?
Changes in consumer spending, investment spending, government spending and
net exports will change AD.
2) What does household wealth refer to?
Household wealth is the value a household’s assets minus its liabilities.
3) What determines the level of government spending?
Fiscal policy of the Congress to enact spending and change tax rates determines
the level of government spending. State and local governments policies may affect
the level of government spending.
4) How do exchange rates impact AD?
Exchange rate appreciation: Domestic goods are becoming more expensive for
foreigners to buy, therefore exports fall and AD shifts left. Exchange rate
depreciation: Domestic goods are becoming cheaper for foreigners to buy,
therefore exports rise and AD shifts right.
© 2015, BFW/ Worth Publishers
Krugman’s Economics for AP®, 2e
Section 4
Teacher’s Resource Materials
Worksheet 17.2: Aggregate Demand
Determine the effect on aggregate demand of each of the following events. Explain
whether it represents a change in quantity demanded represented by a movement along the
curve (up or down) or a change in demand represented by a shift of the curve (left or
right). (Remember, explain means how and why.) Then, in a correctly labeled graph, show
how each of the following will affect the AD curve.
1. Business owners are less optimistic about the health of the economy.
2. The government decreases welfare and veteran’s benefits.
3. The Federal Reserve increases interest rates.
4. A rising price level decreases the value of money held for purchases.
5. The government lowers personal income taxes.
6. Consumers expect the job market to be much stronger in the next few months.
7. The stock market has reached new records high levels of value.
8. The stock of physical capital has been falling for nearly a year.
© 2015, BFW/ Worth Publishers
Krugman’s Economics for AP®, 2e
Section 4
Teacher’s Resource Materials
Copyrighted Material - Do Not Post Answers Online
Worksheet 17.2: Aggregate Demand
Answer Key
Determine the effect on aggregate demand of each of the following events. Explain
whether it represents a change in quantity demanded represented by a movement along the
curve (up or down) or a change in demand represented by a shift of the curve (left or
right). (Remember, explain means how and why.) Then, in a correctly labeled graph, show
how each of the following will affect the AD curve.
1. Business owners are less optimistic about the health of the economy. AD shifts
left; investment spending decreases
PL
AD
AD2
RGDP
2. The government decreases welfare and veteran’s benefits. AD shifts left;
decrease in disposable income and therefore consumer spending
PL
AD2
AD
RGDP
3. The Federal Reserve increases interest rates. AD shifts left; decrease in
investment and interest sensitive consumer spending
PL
AD
AD2
RGDP
PL
AD
4. A rising price level decreases the value of money held for
purchases. There is a movement down the AD curve as
consumer purchasing power erodes
RGDP
© 2015, BFW/ Worth Publishers
Krugman’s Economics for AP®, 2e
Section 4
Teacher’s Resource Materials
Copyrighted Material - Do Not Post Answers Online
5. The government lowers personal income taxes. AD shifts right. Lower taxes implies
higher disposable income so consumer spending rises and AD shifts right
PL
AD2
AD
RGDP
6. Consumers expect the job market to be much stronger in the next few months. AD
shifts right; expectations about future employment increase investment and consumer
spending
PL
AD
AD2
RGDP
7. The stock market has reached new records high levels of value. AD shifts right;
consumer wealth increases causing more consumer spending
PL
AD
AD2
RGDP
8. The stock of physical capital has been falling for nearly a year. AD shifts right;
investment will increase to replace the failing stock of capital.
PL
AD
AD2
RGDP
© 2015, BFW/ Worth Publishers
Krugman’s Economics for AP®, 2e
Section 4
Teacher’s Resource Materials
Exit Slip: Module 17
1. The interest rate effect is the tendency for changes in the price level to affect
A. the quantity of investment demanded and thus affect interest rates.
B. export demand and thus affect aggregate demand.
C. interest rates and thus affect the quantity of investment and consumption
demanded.
D. real incomes and lead to shifts in potential output.
E. interest rates and thus affect the productivity of existing capital equipment.
2. Draw a correctly labeled graph to show the impact of an increase in taxes on aggregate
demand.
3. When the aggregate price level rises, this will, other things equal,
A. lead to a rightward shift in the AD curve.
B. lead to a leftward shift in the AD curve.
C. result in a decrease in the quantity of aggregate output demanded.
D. result in an increase in the quantity of aggregate output demanded.
E. result in a decrease in the quantity of aggregate output supplied.
© 2015, BFW/ Worth Publishers
Krugman’s Economics for AP®, 2e
Section 4
Teacher’s Resource Materials
Copyrighted Material - Do Not Post Answers Online
Exit Slip: Module 17
Answer Key
1. The interest rate effect is the tendency for changes in the price level to affect
A. the quantity of investment demanded and thus affect interest rates.
B. export demand and thus affect aggregate demand.
C. interest rates and thus affect the quantity of investment and consumption
demanded.
D. real incomes and lead to shifts in potential output.
E. interest rates and thus affect the productivity of existing capital equipment.
(C)
2. Draw a correctly labeled graph to show the impact of an increase in taxes on aggregate
demand.
3. When the aggregate price level rises, this will, other things equal,
A. lead to a rightward shift in the AD curve.
B. lead to a leftward shift in the AD curve.
C. result in a decrease in the quantity of aggregate output demanded.
D. result in an increase in the quantity of aggregate output demanded.
E. result in a decrease in the quantity of aggregate output supplied.
(C)
© 2015, BFW/ Worth Publishers
Krugman’s Economics for AP®, 2e
Section 4
Teacher’s Resource Materials
MODULE 17: AGGREGATE DEMAND: INTRODUCTION AND
DETERMINANTS
In-Class Presentation of Module and Sample Lecture
Suggested time: This module can be covered in one hour-long class period.
I.
Aggregate Demand
A.
Why Is the Aggregate Demand Curve Downward Sloping?
1. Wealth Effect
2. Interest Rate Effect
B.
Shifts of the Aggregate Demand Curve
1. Changes in Expectations
2. Changes in Wealth
3. Size of the Existing Stock of Physical Capital
C.
Government Policies and Aggregate Demand
1. Fiscal Policy
2. Monetary Policy
I.
Aggregate Demand
AD is a curve that shows the relationship between the aggregate price level and the quantity of aggregate
output demanded by households, firms, the government, and the rest of the world.
A. Why is the AD curve downward sloping?
Students think that the downward slope of the aggregate demand curve is a natural consequence of the
law of demand.
Since the demand curve for any one good is downward sloping, isn’t it natural that the demand curve for
aggregate output is also downward sloping?
This is a misleading parallel. The demand curve for any individual good shows how the quantity
demanded depends on the price of that good, holding the prices of other goods and services constant.
Example:
The demand curve for apples is downward sloping because all else equal, if the price of apples goes up,
consumers will switch to a substitute fruit like bananas.
With AD, we are talking about the aggregate price level rising for all goods and services in the economy.
1. Wealth or real balances effect
When price level falls, purchasing power of existing financial assets (like money in your savings account)
rises, this can increase consumer spending and there is a downward movement along the fixed AD curve.
2. Interest-rate effect
A decline in price level means lower interest rates which can increase levels of certain types of spending.
How does this work?
© 2015, BFW/Worth Publishers
Krugman’s Economics for AP®, 2e
Section 4, Module 17 | Page 1
Teacher’s Resource Materials
A lower price level increases the purchasing power of money in your pocket so you need to hold less
money to buy your goods and services. This decrease in the demand for money holdings puts downward
pressure on interest rates.
Remind students that we learned that nominal interest rate = real interest rate + expected inflation. If
inflation expectations gradually fall, nominal interest rates should also gradually fall.
Lower interest rates will increase investment spending, thus increasing real GDP along the AD curve.
B.
Shifts of the Aggregate Demand Curve
There are shifts of the aggregate demand curve, changes in the quantity of goods and services demanded
at any given price level.
An increase in aggregate demand means a shift of the aggregate demand curve to the right, as shown in
the figure below.
A rightward shift occurs when the quantity of aggregate output demanded increases at any given
aggregate price level.
A decrease in aggregate demand means that the AD curve shifts to the left. A leftward shift implies that
the quantity of aggregate output demanded falls at any given aggregate price level.
Whether AD shifts to the right or left, that is spending is increasing or decreasing, the multiplier effect is
always at work.
1. Changes in Expectations
When consumers and firms are more optimistic about their future economic prospects, they will increase
consumption and investment spending. This shifts AD to the right.
2. Changes in Wealth
We discussed in the last module that the consumption function shifts up (or consumption spending
increases) if consumer wealth increases. When the value of accumulated household assets goes up,
consumers respond by increasing current consumption. This shifts AD to the right.
This is one reason why a weak stock market or real estate market has a negative ripple effect in the
economy by shifting AD to the left.
© 2015, BFW/Worth Publishers
Krugman’s Economics for AP®, 2e
Section 4, Module 17 | Page 2
Teacher’s Resource Materials
3. Size of the Existing Stock of Physical Capital
Firms plan to invest in physical capital when the stock is being depleted or is insufficient to meet demand
for their products. Therefore, if physical capital stock is being depleted, investment spending will pick up
causing AD to shift to the right.
Alternatively, if firms have plenty of physical capital already, investment spending will slow down. This
will shift AD to the left.
C. Government Policies and Aggregate Demand
Note: prepare the students for future chapters on fiscal and monetary policy by getting them to think
about how the government can affect AD.
Government can have a powerful influence on aggregate demand and that, in some circumstances, this
influence can be used to improve economic performance.
The two main ways the government can influence the aggregate demand curve are through fiscal policy
and monetary policy.
1. Fiscal Policy
Congress and the President control fiscal policy.
Fiscal policy is the use of either government spending—government purchases of final goods and
services and government transfers—or tax policy to stabilize the economy.
Suppose the economy was in a recession. The government can intervene directly or indirectly.
If the government increases spending (G), it will have a direct impact on AD. This is because the overall
demand for goods and services is rising, shifting AD to the right.
If the government decreased taxes, this would increase disposable income, and this would increase
consumption spending.
The increase in C raises demand and would shift the AD curve to the right, helping to indirectly reverse
the recession.
2. Monetary Policy
The Federal Reserve controls monetary policy—the use of changes in the quantity of money or the
interest rate to stabilize the economy.
When the Fed increases the quantity of money in circulation, households and firms have more money,
which they are willing to lend out.*
This drives the interest rate down at any given aggregate price level, leading to higher investment
spending and higher consumer spending.
Thus, increasing the quantity of money shifts the aggregate demand curve to the right.
*Note: It may useful to explain to students the difference between money and income. That is why people
won’t buy more goods with money and choose to lend—because their Consumption spending is related to
income and not money holding.
Students will be exposed in great detail to monetary policy in upcoming chapters of the text.
© 2015, BFW/Worth Publishers
Krugman’s Economics for AP®, 2e
Section 4, Module 17 | Page 3
Teacher’s Resource Materials