Aggregate Demand and AD Curve PDF

Aggregate Demand (AD) and the AD Curve Aggregate demand (AD)= C + I + G + (X-M) The total output (real GDP) that all buyers (consumers, firms, the government, and foreigners) are able and willing to buy at different price levels, ceteris paribus. AD curve shows relationship between real GDP deman...

Aggregate Demand (AD) and the AD Curve Aggregate demand (AD)= C + I + G + (X-M) The total output (real GDP) that all buyers (consumers, firms, the government, and foreigners) are able and willing to buy at different price levels, ceteris paribus. AD curve shows relationship between real GDP demanded & price level, ceteris paribus. The negative relationship between price level and aggregate demand ( Down ward slope) is a result of: The wealth effect: Price level changes affect wealth (value of assets people own). ○ Upward movement along the AD curve, if the price level increases, the real wealth value falls so people feel worse off. ○ Downward movement along the AD curve. If the price level decreases, more output is demanded because real wealth value increases.  The interest rate effect: price level changes affect Interest rates. ○ An increase in price level leads to increased demand for money to buy Items ○ Increase in Interest rates -> cost of borrowing Increases -> decrease in consumer purchases The international trade effect: if domestic price levels increase out, foreign price levels remain the same, exports become more expensive··> foreign buyers demand less. Domestic buyers buy more imports, causing a fall in net exports. The difference between micro- and macroeconomic demand/AD is that macroeconomic AD is about all possible buyers to buy the aggregate output. DETERMINANTS OF AD (SHIFTS) 1. A rightward shift of AD curve – for any price level, a larger amount of real GDP demanded. 2. A leftward shift of AD curve- for any price level, a smaller amount of real GDP demanded. a)Changes in Consumer spending Consumer confidence – how optimist consumers are about the future 1. High confidence: rightward shift 2. Low confidence: leftward shift Interest rate changes 1. Increase in interest rates results in lower consumption: leftward shift 2. Decrease in interest rates results in more consumption: rightward shift Wealth changes 1. Increase in consumer wealth: rightward shift 2. Decrease in consumer wealth: leftward shift Personal income tax changes 1. Increase in personal income tax: leftward shift 2. Decrease in personal income tax: rightward shift Household indebtedness changes – how much $ people owe from taking out loans 1. High levels of indebtedness: leftward shift due to people trying to pay back loans 2. Debt levels that are low: shift to the right b) Changes in Spending on investments. Changes in business confidence are the level of optimism businesses have regarding future sales.  1. High confidence: rightward shift 2. Low confidence: leftward shift Interest rate changes 1. Increase in Interest rate: leftward shift 2. Decrease in Interest rates: rightward shift Improvements in technology – stimulate investment spending: rightward shift Business tax changes 1. Increase in taxes: leftward shift 2. Decrease in taxes: rightward shift Corporate indebtedness changes 1. High debt levels: leftward shift 2. Low debt levels: rightward shift Legal/institutional changes – some economies don’t offer credit to small businesses 1. Increasing credit access: rightward shift C) Changes in Government spending. Political priorities changes 1. Governments have expenditures. Increase in spending: rightward shift 2. Reduced spending: shift to the left D) Changes in Net export. National income abroad changes If a country’s national income increases, it will import more goods from another country, shifting that country’s AD curve to the right. Exchange rate changes Country A’s currency price increase: leftward shift because less exports Country A’s currency price decreases: rightward shift because more exports Trade protection changes Other countries set trade restrictions on imports. leftward shift because less exports NB: Changes in national income cannot cause AD curve shifts because the real GDP axis also represents national income. Short-run aggregate supply & short run equilibrium in the AD-AS model SHORT RUN AND LONG RUN Short run in macroeconomics – a period when resource prices are constant/inflexible or don’t change much, especially in labor costs, even when output increases In terms of wages, there are contracts for wages overtime periods. The long run in macroeconomics is when resource prices are flexible and change with changes in the price level. SHORT RUN AGGREGATE SUPPLY Aggregate supply (AS) – total quantity of goods/ services produced in an economy over a time period at different price levels. Short-run aggregate supply (SRAS) curve – when resource prices remain constant, the relationship between price level and real GDP is shown. There is a positive relationshionship between price level and Aggregate supply (Upward slope) because. 1. An increase in price level means output prices have increased but resource prices have not (short run), so production becomes more profitable. Reasons for the SRAS CURVE SHlFTS ❖ Wage changes (price level constant) 1.) If wages increase, cost of production rises: leftward shift 2.) If wages decrease, cost of production decreases: rightward shift ❖ Non-labor resource price changes 1.)If non-labor resource prices rise: leftward shift 2.)If non-labor resource prices decrease: rightward shift ❖ Business tax changes – they are treated like costs of production 1.) increase in tax: leftward shift 2.) Decrease in tax: rightward shift ❖ Subsidy changes 1.) Increase in subsidies: rightward shift 2.) Decrease in subsidies: leftward shift ❖ Supply shocks 1.) Events that cause a decrease in output: leftward shift 2.) Events that cause increase in output: rightward shift