Aggregate Demand

What causes depressions and recessions?

Inadequate Aggregate expenditure

Aggregate demand

total amount of goods and services demanded by an economy

Aggregate expenditure formula

Consumption + Planned Investment +Government Purchases +Net Exports

Macroeconomic Equilibrium

• Aggregate expenditure is equal to total output

Demand drives short run

• Higher demand than potential extra shifts put on to meet demand

• Lower demand product is stored as inventories and production slowed

Consumption function

• Helps explain how changes in income change consumption

Autonomous Consumption

• The level of consumption regardless of income that everyone will spend

Consumption dependent on income

C1Y

Consumption Total formula

C0 + C1Y

• C1 the multiplier: amount of additional income that will be spent on consumption

Marginal Propensity to consume (MPC)

• Amount of additional income that households will spend

• Poor households large

• Wealthy households small

Marginal Propensity to save

• amount of extra income a household will save

• Small for poor

• Large for wealthy

MPC Formula (Multiplier)

1/ (1-MPC)=

MPS Formula

1/ MPS

Multiplier Effect

• change in output can be greater than initial change in aggregate demand

• The multiplier represents the relative magnitude if this change

Multiplier 1

Increase in GDP = Initial increase in spending

Multiplier >1

Increase in GDP> Initial increase in spending

Multiplier <1

Increase in GDP< increase in spending

Goods Market Equilibrium

Output (Y)= Aggregate Demand (AD)

Multiplier process

• Fall in investment

• Fall in aggregate demand

• Fall in output and income

• Further fall in demand and income

• Repeats

• New equilibrium

Multiplier is good as…

it shows how small changes in ( C, I, G, NX) can have. big affect on the economy

Withdrawals from circular flow of income

savings, imports, taxes

MPT

Marginal propensity to taxation

MPM

Marginal propensity to imports

MPW

(MPT + MPM +MPS)