Aggregate Demand (AD)

·         Shows the amount of Real GDP that the private, public and foreign sector collectively desire to purchase at each possible price level

·         The relationship between the price level and the level of Real GDP is inverse

·         Aggregate Demand Curve has: Price Level on the Y-axis, GDP on the X-Level, AD curve goes to the sand

·         Why AD is downward Sloping:

o   Real Balance Effect: When the price-level is high households and businesses cannot afford to purchase as much output. When the price-level is low, households and businesses can afford to purchase more output. 

o   Interest-Rate Effect: A higher price-level increases the interest rate which tends to discourage investment. A lower price level decreases interest rate which tends to encourage investment.

o   Foreign Purchases Effect: A higher price-level increase the demand for relatively cheaper imports. A lower price-level increases the foreign demand for relatively cheaper U.S. exports.

     Shifts in Aggregate Demand:

o   There are two parts to a shift in AD:

§  A change in C, Ig, G, and/or Xn

§  A multiplier effect that produces a greater change than the original change in the 4 components

§  Increases in AD = AD to the right

§  Decreases in AD = AD to the left

Consumption:  Household spending is affected by:

      ·         Consumer Wealth

o   More wealth = more spending (AD to the right)

o   Less Wealth = Less Spending (AD Left)

·         Consumer Expectations

o   Positive Expectations = More Spending (AD right)

o   Negative Expectations = less spending (AD shifts left)

·         Household indebtedness

o   Less debt = more spending (AD right)

o   More debt = less spending (AD Left)

·         Taxes

o   Less taxes = more spending (AD right)

o   More taxes = Less spending (AD Left)

o   Gross Private Domestic Investment: Investment Spending is Sensitive to:

·         The Real Interest Rate

o   Lower Real Interest Rate = More Investment (AD Right)

o   Higher Real Interest Rate = Less Investment (AD Left)

·         Expected Returns

o   Higher Expected Returns = More Investment (AD Right)

o   Lower Expected Returns = Less Investment (AD Left)

                       o   Expected Returns are influenced by:
§  Expectations of future profitability
§  Technology
§  Degree if Excess Capacity (Existing Stock of Capital)
§  Business Taxes

o   Government Spending
§  More Government Spending (AD Right) 
§  Less Government Spending (AD Left

o   Net Exports
§  Net Exports are sensitive to:
·         Exchange Rates (International Value of $)
o   Strong $ = More imports and fewer exports = (AD Left)
o   Weak $ = Fewer imports and more exports = (AD Right)
·         Relative Income
o   Strong Foreign Economies = More exports = (AD Right)
o   Weak Foreign Economies = Less Exports = (AD Left)