Aggregate Demand Curve

Aggregate-Demand Curve

  • AD-AS model
    • Model of aggregate demand (AD) & aggregate supply (AS)
    • Used to explain short-run fluctuations in economic activity around its long-run trend

Aggregate-Demand Curve

  • Aggregate-demand curve: shows the quantity of goods and services that households, firms, the government, and customers abroad want to buy at each price level.
    • Downward sloping

Figure 1: Aggregate Demand Curve

  • The model of aggregate demand and aggregate supply is used to analyze economic fluctuations.
  • Vertical axis: overall level of prices.
  • Horizontal axis: economy’s total output of goods and services.

Aggregate-Demand Curve

  • Why does AD curve slope downward?
    • Wealth effect
      • Price increases → real wealth falls
      • Example: you have $100, and price of a movie ticket goes from $10 to $20.
        • Before → 10 tickets
        • After → only 5 tickets
        • real wealth ↓
    • Exchange-rate effect
      • Higher domestic prices → cause fewer exports by U.S. Firms

Figure 2: The Aggregate-Demand Curve

  • An increase in the price level from P1 to P2 decreases the quantity of goods and services demanded from Y1 to Y2.
  • Reasons for this negative relationship:
    • As the price level increases, real wealth falls, and the exchange rate appreciates.
    • These effects depress spending on consumption and net exports.
    • Decreased spending on any or all of these components of output means a smaller quantity of goods and services demanded.

Aggregate-Demand Curve

  • What will cause the AD curve to shift?
    • Changes in consumption (C)
    • Changes in investment (I)
    • Changes in government purchases (G)
    • Changes in net exports (NX)
    • Y = C + I + G + NX

Aggregate-Demand Curve

  • Changes in consumption, C
    • Events that change how much people want to consume at a given price level
    • Changes in taxes, wealth
    • If C increases → AD shifts to the right

Aggregate-Demand Curve

  • Changes in investment, I
    • Events that change how much firms want to invest at a given price level
      • Better technology
      • Tax policy
      • Money supply
    • If I increases → AD shifts to the right

Aggregate-Demand Curve

  • Changes in government purchases, G
    • Policy makers change government spending at a given price level
      • Build new roads
    • If G increases → AD shifts to the right

Aggregate-Demand Curve

  • Changes in net exports, NX
    • Events that change net exports for a given price level
      • NX = Exports - Imports
        • Recession in Europe
        • Change in the exchange rate
    • If NX increases → AD shifts to the right

Figure 3: Increase in Aggregate Demand

Figure 4: Decrease in Aggregate Demand