ECO- chapter 9.1

aggregate demand

total amount of real output (real GDP) that consumers, firms, the govt and foreigners want to buy eat each possible price level, over a particular time period

the aggregate demand AD curve

shows relationship between the total amount of real output demanded by the four components and the economy’s price level over a particular time period.

it is downward sloping, indicating a negative relationship between the price level and the aggregate output demanded

aggregate demand curve

AD curve shifts

rightward shift from AD1 TO AD2 means AD increases: for any price level higher GDP is demanded

leftward shift from AD1 TO AD3 means AD decreases: for any price level a smaller amount of GDP is demanded

shifts of aggregate demand curve are causes by

1. changes in consumer spending

2. changes in investment spending

3. changes in government spending

4. changes in foreigners’ spending

reasons for changes in consumer spending

1. change in consumer confidence

2. changes in interest rates (monetary policy)

3. changes in wealth

4. changes in personal income taxes (fiscal policy)

5. changes in the level of household indebtedness expectations of future price levels

changes in investment spending

1. changes in business confidence

2. changes in interest rates (monetary policy)

3. improvement of tech

4. changes in business taxes (fiscal policy)

5. changes in the level of corporate indebtedness legal/institutional changes

changes in govt spending

1. changes in political priorities

2. changes in economic priorities: deliberate efforts to influence AD (fiscal policy)

changes in foreigners’ spending

1. changes in national income abroad

2. changes in exchange rats

3. changes in the level of trade protection

change in consumer confidence (change in consumer spending)

• consumer confidence is the measure of how optimistic consumers are about their future income and the future of the economy

• if consumers are optimistic, they spend more on buying goods and services and AD curve shifts right

• low consumer confidence= falling incomes and worsening economic conditions and hence to due to fars of cuts in wgaes or unemployment —> decrease in spending and left shift of AD curve

• level of consumer confidence is measured by govts to predict level of consumer spending

changes in interest rates (change in consumer spending)

• consumer spending is also financed through borrowing hence interest rates matter

• left shift: increase in interest making borrowing more expensive and low consumer spending

• right shift: fall in interest rates makes borrowing less expensive and more consumer spending

changes in wealth (change in consumer spending)

• wealth is the value of assets people own

• increase in wealth makes people feel more reach, thus more consumer spending and right shift of AD curve

• decrease in wealth lowers AD and AD curve shifts to the right

changes in income taxes (change in consumer spending)

• increase in income taxes would lead to decrease in consumer disposable income hence spending drops and AD curve shifts toward left

• lower income taxes would increase disposable income, spending increases AD curve shifts right

change in the level of household indebtness (change in consumer spending)

high levels of indebtedness lower consumer spending and shift AD curve to left because consumers feel pressure to pay the high monthly payments and pay back their loan plus interest.

low level of indebtedness increases consumer spending and ad curve shifts to right

expectation to future price levels (change in consumer spending)

often consumers expect prices to fall or rise and hence delay their consumption

expecting fall- consumer spending decrease- ad curve left

expecting rise- consumer spending increase- ad curve right

change in business confidence (change in investment spending)

business confidence is the optimism businesses have for their future sales and economic activity

if optimistic, they spend more on investment and AD curve shifts to right

if pessimist, results in leftward shift

change in interest rates (change in investment spending)

increase in interest rates raises cost of borrowing, forces businesses to reduce investment spending financed through borrowing. ad curve shift left

if interest rates are low, spending by borrowing at a lower cost, the AD curve shifts right

result of monetary policy

improvement in tech (change in investment spending)

improvements in tech stimulate investment spending, thus causing increases in aggregate demand and a rightward shift in the AD curve

changes in business taxes (change in investment spending)

=taxes on profits (corporate income taxes)

if taxes rise, after tax profits fall and investment spending falls —> left shift in ad curve

decrease in profits on taxes increases aggregate demand and a rightward shift in ad curve

level of corporate indebtedness (change in investment spending)

with high levels of debt due to borrowing, businesses are less willing to make investments and the AD curve will shift to the left

low level of corporate indebtedness, leads to more investment and a rightward shift in ad curve

legal/institutional changes

some countries mostly developing lack laws and institutions for businesses. small businesses face a lot of issues, like not having access to credit fence can do investment spending through borrowing. many developing economies don’t have proper laws for securing property rights (legal rights to ownership). this decreases ad

in such situations, increasing access to credit (ability to borrow) and securing property rights would result in increases in investment spending, shifting AD curve to right

change in political priorities (causes of changes in govt spending)

govts have many expenditure, arising from provision of merit goods and public goods, spending on subsidies and pensions, payments of wages and salaries to employees, purchases of goods for own use and on

increase in govt spending, ad curve right and reverse also

changes in economic priorities: deliberate efforts to influence aggregate demand (change in govt spending)

govts can use its own spending to influence the aggregate demand

changes in national income abroad (changes in export spending minus import spending)

countries are dependant on each other

if country B’s national income increases, it will import more goods and services from country A, so that country A can increase their exports AD curve would shift to the right

if country B, national income falls, country A’s exports decreases and ad curve shifts to left cha

change in exchange rates (changes in export spending minus import spending)

increase in price of a country’s currency has two effects, fall in exports because other countries find it too expensive and increase in imports because imports are cheaper—> ad curve shifts left due to X-M

and opposite

price of country A’s currency decreases exports increase imports decrease —> ad curve right due to X-M

change in trade policies and level of trade protection (changes in export spending minus import spending)

trade protection= restrictions to free international trade often imposed by govts.

take example of country B putting trade restriction on imports from from country A. now country A ad curve to left. for country B lower imports means X-M increases so AD curve shifts to right