macroeconomics - aggregate demand and supply

aggregate demand definition

total demand for a nation's goods and services from domestic households, firms, the government and foreigners.

also known as the total quantity of goods and services that all buyers in an economy want to buy at different possible price level, ceteris paribus

AD curve

aggregate demand formula

C + I + G + (X-M)

C = demand of consumers

I = demands of firms

G = demand of government

X = demand of foreigners for exports

M = demand of domestic buyers for imports

3 reasons for aggregate demand being downward sloping

1. the wealth effect

2. the interest rate effect

3. the net export effect

what is the wealth effect

changes in price level affect the real value of people's wealth (NOT income)

what is wealth

it is equity

assets - liabilities

economic theory - the wealth effect

as the prices go up, liabilities increase, but assets stay the same, which reduces wealth

OR

1. PL increase

2. households' liabilities increase

3. households' wealth decreases

4. households' consumption decreases

5. since consumption (C) is a component of real GDP; real GDP decreases

what is the interest rate effect

changes in price level have impact on rates of interest which in turn affect aggregate demand

interest rate is

the cost of borrowing money

economic theory - interest rate effect

1. PL increases

2. Interest rates increase

3. HHs: more savings and less borrowing --> less consumption

4. Since consumption (C) is a component of RGDP, RGDP decreases

what is the net export effect

also known as international trade effect

--as the price level in a particular country falls, ceteris paribus, goods and services produced in that country become more attractive to foreign customers

--likewise, domestic consumers find imports less attractive as they now appear relatively more expensive, so the net expenditure on exports rises as price level falls

economic theory - net export effect

1. PL increases

2. Imports increase

3. Net exports decrease

4. Since net exports (X-M) are a component of RGDP, RGDP decreases

what does right shift of AD mean?

it means that aggregate demand increases: for ay particular price level, a larger amount of real GDP is demanded

what does left shift of AD mean?

it means that aggregate demand decreases: for any particular price level, a smaller amount of real GDP is demanded

what causes shifts of aggregate demand?

changes in components of AD

AD = C + I + G + Xn

1. changes in consumer spending (C)

2. changes in investment spending (I)

3. changes in government spending (G)

4. changes in foreigners' spending (Xn)

6 changes in consumer spending

1. a change in wealth

--value of household's assets minus liabilities

2. a change in expectation about future incomes and prices

3. a change in interest rates (returns on saving more)

4. a change in personal income taxes (due to fiscal policy)

5. a change in level of household indebtedness

6. a change in the attitudes towards spending

explain a change in interest rates

returns on saving more

if interest rates are higher, households will prefer to save more and consume less.

At lower interest rates, consumption is higher and saving is less

explain a change in level of household indebtedness

at high debt levels, households must allocate more income to paying off debt, therefore consumption falls

explain a change in the attitudes towards spending

consumer confidence

explain a change in personal income taxes (due to fiscal policy)

A tax cut boosts disposable income, allowing for higher spending, while a tax increase reduces it

what is fiscal policy

the use of government spending and taxation to influence a nation's economy, particularly to manage economic growth, inflation, and unemployment

level of taxation and government spending

2 changes in investment spending

1. interest rates

2. expectations of firms (business confidence)

explain change interest rates in terms of investment spending

at lower interest rates, firms borrow more money and buy more new capital equipment.

if interest rates are higher, firms will invest less

explain change in expectation of firms (business confidence) (4 things)

1. a change (improvement) in technology

2. a change in business taxes (due to fiscal policy)

3. legal/institutional changes

4. a change in expectations about future sales

if firms are confident about future business opportunities ____

if expectations are poor ____

they make higher investment

firms will invest less

2 changes in government spending

1. fiscal policy

2. government debt/political priorities

explain changes in fiscal policy

lower taxes increase the AD

higher taxes decrease the AD

explain changes in government debt/political priorities

more debt may mean more government spending in the short-run, so taxes have to be raised and government spending must fall if there is too much government debt

what does short run mean in macroeconomics

this is the period of time during which the nominal pries of resources, particularly the price of labor (wages), don't change in response to changes in price level.

we can think of resource prices as being constant

what does long run mean in macroeconomics

this is the period of time in which the nominal prices of all resources, including the price of labor change, so as to reflect fully any change in price level.

5 reasons for uncahnging wages

1. labor contracts fix wage rates for certain periods of time, perhaps a year, or 2, or more

2. minimum wage legislation fixes the lowest legally permissible wage

3. workers and labor unions resist wage cuts

4. wage cuts have negative impacts on worker morale, causing firms to avoid them

5. ideas of fairness may dictate the level of wages

aggregate supply definition

this is the total quantity of goods and services produced in an economy at different price levels, ceteris paribus

short run aggregate supply (SRAS)

this shows the relationship between the price level and the quantity of real GDP produced by firms when resource prices (particularly wages) do not change.

SRAS curve

reason for SRAS being upward sloping

profitability

5 changes in SRAS (shifts in the SRAS curve)

1. changes in wages

2. changes in non-labor resource prices

3. changes in business taxes

4. changes in subsidies offered to business

5. supply shocks

explain changes in wages SRAS

if they increase, SRAS shifts left

explain changes in non-labor resource prices SRAS

if resource prices increase, SRAS shifts left

explain changes in business taxes SRAS

lower taxes for businesses or lower taxes for consumers - boosts AS, shifts right

explain changes in subsidies offered to business SRAS

a) an industry that holds a large share of national econ's capacity - to boost AS

b) an energy provider -- energy prices decrease, AS shifts right

explain supply shocks SRAS

natural or hand-made disasters that delay/destroy production in the short run, especially climate change.

shift in SRAS