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