Download Aggregate Demand

Long Run vs. Short Run
•  Long Run: A period long enough for nominal
wages and other input prices to change in
response to a change in the nation’s price level.
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The Basic Model of Economic Fluctuations
•  Two variables are used to develop a model to
analyze the short-run fluctuations.
•  Real GDP
•  Price Level
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The Basic Model of Economic Fluctuations
The AS-AD Model
Economist use the model of aggregate demand and
aggregate supply to explain short-run fluctuations
in economic activity around its long-run trend.
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The Basic Model of Economic Fluctuations
•  The aggregate-demand curve shows the quantity of
goods and services that households, firms, and the
government want to buy at each price level.
•  The aggregate-supply curve shows the quantity of
goods and services that firms choose to produce and
sell at each price level.
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Aggregate Demand and Aggregate Supply...
Price
Level
Aggregate
supply
Equilibrium
price level
Aggregate
demand
0
Equilibrium
output
Quantity of
Output
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THE AGGREGATE-DEMAND CURVE
The four components of GDP (Y) contribute to
the aggregate demand for goods and services.
Y = C + I + G + NX
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Figure 3 The Aggregate-Demand Curve...
Price
Level
P
P2
1. A decrease
in the price
level . . .
0
Aggregate
demand
Y
Y2
Quantity of
Output
2. . . . increases the quantity of
goods and services demanded.
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Why the Aggregate-Demand Curve Is
Downward Sloping
•  The Real Balances Effect (Wealth Effect)
•  The Interest Rate Effect
•  The Foreign Purchases Effect (Exchange-Rate
Effect)
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The Real Balances Effect (Wealth Effect)
The Price Level and Consumption
•  A lower price level leads to more consumption
spending due to the increase in the purchasing
power of the public’s accumulated savings
balances. This makes consumers feel more
wealthy, which in turn encourages them to spend
more.
•  This increase in consumer spending means larger
quantities of goods and services demanded.
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The Interest Rate Effect
The Price Level and Investment
•  A higher price level increases money demand.
Assuming a fixed supply of money, the interest rate
increases.
•  This causes a decrease in business investment and a
decrease in interest sensitive consumption, leading
to a larger quantity of goods and services
demanded.
.
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The Foreign Purchases Effect
(Exchange-Rate Effect)
The Price Level and Net Exports
•  When the price level rises relative to foreign price
levels, foreigners buy fewer domestic goods
(exports) and domestic consumers buy more foreign
goods (imports).
•  Also, when a fall in the domestic price level causes
domestic interest rates to fall, the real exchange rate
depreciates, which stimulates net exports.
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Determinants of Aggregate Demand
•  What shifts AD?
• 
• 
• 
• 
Consumption
Investment
Government Purchases
Net Exports
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Increase in AD
Decrease in AD
Consumer Spending
Each of the following influence consumption
• 
• 
• 
• 
Consumer wealth
Consumer expectations
Consumer indebtedness
Personal income taxes
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Business Spending
Each of the following influence investment
• 
• 
• 
• 
Interest rates
Profit expectations on business projects
Technology
Degree of excess capacity
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Government Spending
The amount of government spending depends
on outlays in the national budget. G will
increase as outlays increase and decrease as
outlays decrease.
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Net Export Spending
Net Exports = Exports - Imports
Each of the following influence net exports
•  National income abroad
•  Exchange rates
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