Section 5: The Aggregate Demand Curve (AD)

Aggregate Demand (AD) Curve

A curve that shows the inverse relationship between the price level and the quantity of real GDP demanded by the economy (households, firms, and government)

The Wealth Effect

• Rising prices reduce the real value of household wealth, causing people to feel poorer and decrease Consumption ($C$).

The Net Exports Effect

• Rising U.S. prices make U.S. goods more expensive relative to foreign goods, causing imports to rise and exports to fall, decreasing Net Exports ($NX$).

The Interest Rate Effect

1. Rising prices increase the demand for money (for transactions). If the money supply is constant, interest rates must rise, causing Planned Investment ($I$) to fall.

Derivation of the AD Curve

An increase in the price level causes the Aggregate Expenditure (AE) function to shift down. This results in a new, lower equilibrium GDP, which corresponds to a movement up and to the left along the Aggregate Demand (AD) curve.