Download Aggregate Supply & Demand

Aggregate Demand
Introduction to AD/AS Model
Most important model in AP Macro
Aggregate Supply & Demand Model
• Economists developed the AS/AD model to explain shortrun fluctuations in Real GDP around its long-run trend
Economic
activity
Business
cycle
(Real GDP)
Long Run
“full potential”
Trend Line
Time
AS & AD Model
• Price Level
Price
Level
– A measure of inflation (think CPI or GDP deflator)
• Real GDP (or output )
– economy’s output of final goods and services
AD1
Real GDP
Aggregate Demand
• Aggregate-demand curve (AD)- how demand for the
entire economy changes with inflation (price level)
– demand from households, firms, exports & government at each price level
• 4 Components of AD :
AD = C + I + G + NX
Price
Level
AD1
Real GDP
AD = C + I + G + NX
Shifts in AD Curve
• Shifts arise from changes in any of the 4 Determinants of AD
– Consumption
– Investment
AD = C + I + G + NX
– Government Purchases
– Net Exports
Price
Level
AD2
AD2
AD1
Real GDP = Y
3 Reasons AD is Downward Sloping
1. The Wealth Effect
2. The Interest Rate Effect
3. The Exchange-Rate Effect
AD = C + I + G + NX
Wealth Effect (consumption)
• As price level falls => real value of wealth/savings ↑
– Consumers feel wealthier (purchasing power ↑) => spend more!
Y = C + I + G + NX
Interest Rate Effect (Investment)
• A lower price level lowers real interest rates
– Why: consumers “hold” less money (save more money)
– More savings leads to lower real interest rates which raises
Y = C + I + G + NX
Exchange Rate Effect
• A lower price level makes U.S. goods cheaper to foreigners
– Reduced “price” leads to more EXPORTS (U.S. exports look cheap!)
Y = C + I + G + NX
NX ↑
Price
Level
Worksheet Part I
1. The Wealth Effect
2. The Interest Rate Effect
3. The Exchange-Rate Effect
AD1
Real GDP