AP Macro Unit 3 (11/14)

Aggregate Demand

graph showing relationship between price level and spending on REAL GDP

(this) curve shows if price level decreases, then real GDP increases

(inverse relationship)

Fiscal Policy

the use of taxes, government spending, or government transfers to affect real GDP

Price Level

measure that captures all the prices that exist in an economy

(e.g. CPI, GDP Deflator)

Real Wealth Effect

occurs when a change in the price level leads to a change in consumer spending;

• happens b/c assets have more or less purchasing power.

• If the price level decreases, then money in your bank account can suddenly buy more stuff, so you feel wealthier & buy more stuff

Interest Rate Effect

• occurs when a change in the price level leads to a change in interest rates and interest sensitive spending;

• when the price level drops, you keep less money in your pocket and more in the bank; this drives down interest rates & leads to more investment spending & more interest-sensitive consumption

Exchange Rate Effect

(sometimes called the foreign purchases effect)

• when a change in the price level in one country leads to other countries purchasing more of that country’s goods.

• makes net exports (and therefore real GDP) increase. If the price level in US decreases, then its goods are cheaper relative to China, which means US’s exports increase and its real GDP increases.

Wealth effect, interest rate effect, and exchange rate effect

Reasons Why Aggregate Demand Curve is Downward Sloping

Components of Aggregate Demand

Consumption, Investment, Gov. spending, Net exports