02/12/16      UNIT 3: Aggregate Demand vs. Supply

Aggregate Demand Curve (AD)

- AD is the demand by consumers, government, and foreign countries.

-What definitely doesn't shift the curve? Changes in price level.

*Formula for AD*

Reason for downward slope of AD curve:

1.) Real-Balance Effect:

• Higher price levels reduce the purchasing power of money.
• Lower price levels increase purchasing power and increase expenditures.
• This decreases the quantity of expenditures.

2.) Interest-Rate Effect:

• When the 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. 

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 decreasing) 

Full Employment: - where AD intersects LRAS & SRAS at the same point.

Recessionary Gap: -when equilibrium occurs below full employment output.

Inflationary Gap: - when equilibrium occurs beyond full employment output.

• More wealth = more spending (AD shifts ->)
• Less wealth = less spending (AD shifts <- )

Consumer Expectations

• Positive expectations = more spending (AD shifts ->)
• Negative expectations = less spending (AD shifts <-) 

Household indebtedness

• Less debt = more spending (AD shifts ->)
• More debt = less spending (AD shifts <- )

Taxes

• Less taxes = more spending (AD shifts ->)
• More taxes = less spending (AD shifts <- )

Gross Private Investment: 
Investment Spending is sensitive to:
The Real Interest Rate

• Lower Real Interest Rate = More Investment (AD ->)
• Higher Real Interest Rate = Less Investment (AD <- )

Expected Returns

• Higher Expected Returns = More Investment (AD ->)
• Lower Expected Returns = Less Investment (AD <- )
• Expected Returns are influenced by:

           - Expectations of future profitability
           - Technology
           - Degree of Excess Capacity (Existing Stock of Capital)
           - Business Taxes

Government Spending: 

• More Government Spending (AD ->)
• Less Government Spending (AD <- )

Net Exports:
Net Exports are sensitive to: 
Exchange Rates (International value of $)

• Strong $ = More imports & Fewer Exports = (AD <- )
• Weak  $ = Fewer Imports & More Exports = (AD ->)

Relative Income

• Strong Foreign Economics = More Exports = (AD ->)
• Weak Foreign Economics = Less Exports = (AD <- )