12.2 Changes in Aggregate Demand

What causes a movement along the AD curve?

A change in the price level.

Represents changes in the amount of real GDP demanded that occur in response to a change in the price level

What causes the AD curve to shift?

A change in one of the determinants of aggregate demand.

What are the two stages of an AD shift?

1. Initial change in spending

2. Multiplier effect that magnifies the change

OR

A change in a determinant of aggregate demand that causes an initial change in the amount of real GDP demanded.

A multiplier effect that magnifies that initial change in spending to produce a larger ultimate change in aggregate demand.

If MPC = 0.75 and investment increases by $5B, what’s the total AD shift?

$20B (Multiplier = 1 / (1 - 0.75) = 4 → $5B × 4 = $20B)

What are the 4 consumer spending determinants?

Consumer wealth, consumer expectations, household borrowing, personal taxes

What is consumer wealth?

Assets (stocks, bonds, real estate) minus liabilities (loans, mortgages, credit card debt)

How does a sudden increase in consumer wealth affect AD?

Consumers spend more → AD shifts right (wealth effect)

How does a sudden decrease in consumer wealth affect AD?

Consumers save more, spend less → AD shifts left (reverse wealth effect)

How do expectations of higher future income or inflation affect AD?

Consumers spend more now → AD shifts right

How do expectations of lower future income or prices affect AD?

Consumers spend less now → AD shifts left

How does household borrowing affect AD?

• More borrowing → AD shifts right

• Less borrowing or more debt repayment → AD shifts left

How do personal taxes affect AD?

• Tax cuts → AD shifts right

• Tax increases → AD shifts left

What are the 6 investment spending determinants?

Real interest rates, expected returns, business expectations, technology, excess capacity, business taxes

How do real interest rates affect AD?

• Rates ↑ → borrowing costs ↑ → investment ↓ → AD shifts left

• Rates ↓ → borrowing costs ↓ → investment ↑ → AD shifts right

What causes real interest rates to change?

Changes in the money supply

How do expected returns affect AD?

• Higher expected returns → AD shifts right

• Lower expected returns → AD shifts left

How do business expectations affect AD?

• Optimism → investment ↑ → AD shifts right

• Pessimism → investment ↓ → AD shifts left

How does technology affect AD?

New tech raises expected returns → investment ↑ → AD shifts right

How does excess capacity affect AD?

• More excess capacity → less incentive to invest → AD shifts left

• Less excess capacity → more incentive to invest → AD shifts right

How do business taxes affect AD?

• Higher taxes → lower after-tax profits → AD shifts left

• Lower taxes → higher profits → AD shifts right

Why is investment spending unstable?

It fluctuates often due to changes in interest rates and expected returns.

How does government spending affect AD?

• More spending → AD shifts right

• Less spending → AD shifts left

What are the 2 determinants of net export spending?

National income abroad and exchange rates

How does rising national income abroad affect AD?

Foreigners buy more U.S. goods → exports ↑ → AD shifts right

How does falling national income abroad affect AD?

Foreign demand ↓ → exports ↓ → AD shifts left

How does dollar depreciation affect AD?

• U.S. goods cheaper for foreigners → exports ↑

• Foreign goods more expensive for Americans → imports ↓

• Net exports ↑ → AD shifts right

How does dollar appreciation affect AD?

• U.S. goods more expensive → exports ↓

• Foreign goods cheaper → imports ↑

• Net exports ↓ → AD shifts left

Other things being equal, according to the aggregate demand curve, a decrease in the price level will increase the amount of aggregate___________

Spending

If consumers expect inflation in the near future, consumers will want to buy more products now and Blank______.

Aggregate demand will increase

Which of the following are the four components or determinants of aggregate demand?

• Investment spending

• Consumer spending

• Net export spending

• Government spending