Download Aggregate Demand and Supply

Aggregate Demand
Krugman Section 4 Module 17
Aggregate Demand

Aggregate demand is NOT demand
(single product—price and quantity--the
curve is downward sloping because
people will demand more at a lower price)
Is a schedule that shows the amounts of
GDP & Price Level
 Shows an inverse relationship between
price level and domestic output
 The explanation of the inverse relationship
is not the same as for demand for a single
product

 Substitution
effect doesn’t apply in the
aggregate case, since there is no substitute
for “everything”
Explanation of Inverse Relationship

Real Balance Effect or Wealth Effect
 As
the PL falls, cash will buy more, so people
will spend more, thus increasing real output.

Interest-Rate Effect
 Lower
interest rates can increase levels of
certain types of spending (Ig)

Foreign Purchases Effect or Net Export
Effect

when PL falls, other things being equal, US
prices will fall relative to foreign prices, which
will tend to increase spending on US exports
(X) and also decrease import (M) spending in
favor of US products
Determinants of A.D.

The “other things” (besides price level)
that can cause a shift or change in
demand

1. Changes in consumer spending (C),
which can be caused by:
Consumer wealth – “Wealth Effect” of
income (liquidity, inflation and “real” income)
 B. Future expectations of wages and wealth
 C. Levels of indebtedness and response to
more purchases
 D. Net income after tax payments
 A.

2. Changes in investment spending (Ig),
which can be caused by:
 A.
Interest rates or the cost of borrowing
 B. Future profit expectations
 C. Profit after taxes
 D. Available technology and time to adjust to
technology
 E. Amount of unused capital

3. Change in gov’t spending (G)
 Spending

on G and Services
4. Changes in net exports (Xn) unrelated
to PL, which may be caused by:
 Income
abroad
 Exchange rates

Depreciation of the dollar encourages US exports
 and discourages import buying
What shifts the A.D. Curve?
PL
AD2
AD
AD3
GDPr
Situation
1. Congress cuts income taxes
2. Interest rates increase causing
businesses to buy less new
equipment.
3. Survey shows consumer
confidence jumps
4. Price level falls. Foreigners buy
our goods.
5. Productivity rises for the 4th year
6. President cuts defense
spending by 20%; no increase in
domestic spending
change in AD
Determinant
Situation
change in AD
Determinant
↑
↓
C
Ig
3. Survey shows consumer
confidence jumps
↑
C
4. Price level falls. Foreigners buy
our goods.
↑
Xn
5. Productivity rises for the 4th year
NC
↓
G
1. Congress cuts income taxes
2. Interest rates increase causing
businesses to buy less new
equipment.
6. President cuts defense
spending by 20%; no increase in
domestic spending