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UNIT 3 - Aggregate Demand (AD)


AD is the demand by consumers, businesses, gov't and foreign countries (C+Ig+G+Xn)
*shows the amount of real GDP that the private, public and foreign sector collectively desire to purchase at each possibe price level
*The relationship bet. price level and level of real GDP is inverse

Aggregate Demand Curve
x-axis: Real Domestic Output (GDPr)
y-axis: Price level
Changes in price level cause a move along the curve not a shift of the curve (shift only left or right, increase or decrease)
Downward Sloping
1) Wealth Effect
  -Higher prices reduce the pourchasing power of $
  -This decreases the quantity of expenditures
  -Lower price levels increase purchasing power and increase expenditures
 -Ex: If the balance in your bank was $50,00, but inflation erodes your purchasing power, you will reduce your spending, so price level goes up, GDP demanded goes down.
2)  Interest-Rate Effect
 -As price level increases, lenders need to charge higher interest rates to get a real return on their loans
 -Higher interest rates discourage consumer spending and business investment
 -Ex: increase in prices leads to an increase in the interest rate from 5% to 25%. You are less likely to take out loans to improve your business
 -Result....Price level goes up, GDP demanded goes down (and Vice Versa)
3) Foreign Trade Effect
-When U.S price level rises, foreign buyers purchase fewer U.S goods and Americans buy more foreign goods
-Exports fall and imports rise causing real GDP demanded to fall. (Xn Decreases)
-Ex: If prices triple in the U.S, Canada will no longer buy U.S goods causing quantity demanded of U.S products to fall.

Shifts in AD
*There are TWO parts to a shift in AD
-∆ in C, Ig, G and/or Xn
-A multiplier effect that produces a greater ∆ than the orig. ∆ in the 4 components
*↑ in AD
*↓ in AD

Determinants of AD
*Consumption (C)
*Gross Private Investment (Ig)

>>Change in Consumer Spending
Consumer Wealth (Boom in the stock market)
Consumer Expectations (people fear a recession)
Household Indebtedness (More consumer debt)
Taxes (Decrease in income taxes)

>>Change in Investment Spending
Real IR (price of burrowing $)
              (If IR increase...)
              (If IR decrease...)
Future Business Expectations

>>Change in Gov't Spending
(War...)
(Nationalized Health Care..)
(Decrease in defense Spending...)

>>Change in Net Exports (X-M)
Exchange Rates
(if the us dollar depreciates relative to the euro...)
National Income Compared to Abroad
If a major importer has a recession
if the US has a recession

"If the US get a cold, Canada gets Pneumonia"
AD = GDP=C+I+G+Xn

Government spending
*More G(AD >)
*Less G(AD <)

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