Macro 3.1 - Aggregate Demand

Introduction to Aggregate Demand

• Aggregate Demand (AD): Total demand for all goods and services within the economy.

• Graph: Price level on the Y-axis and Real GDP on the X-axis.

  • Real GDP also known as national income and correlates with employment levels.

  • More output leads to more jobs, less output leads to higher unemployment.

Characteristics of the Aggregate Demand Curve

• Curve: Downward sloping.

• Inverse relationship: Higher price levels correlate with lower quantities of Real GDP demanded, and vice versa.

• Label: AD for aggregate demand.

Reasons for Downward Sloping Aggregate Demand Curve

1. Wealth Effect

• Definition: When price levels rise, wealth buys fewer goods, leading to a decrease in Real GDP.

• Inverse Relationship: Higher price levels = lower GDP; lower price levels = higher GDP.

2. Interest Rate Effect

• Definition: Higher price levels result in higher nominal interest rates, reducing gross investment.

• Impact: More expensive borrowing leads to less investment, thus decreasing Real GDP.

• Inverse Relationship: Lower price levels = lower nominal interest rates = more investment and higher GDP.

3. Net Export Effect

• Definition: Rising price levels make U.S. goods more expensive, leading to decreased exports and increased imports.

• Impact: Price rises = less demand from foreign buyers; drops in net exports reduce Real GDP.

• Inverse Relationship: Lower price levels = higher exports and lower imports, increasing net exports and GDP.

Movement vs. Shifts in the Aggregate Demand Curve

• Movement Along the Curve: Caused by a change in the price level leading to a change in quantity of Real GDP demanded.

  • Related to effects mentioned earlier (Wealth, Interest Rate, and Net Export).

• Shifts of the Curve: Caused by changes in components of the GDP output-expenditure formula, expressed as C + I + G + (X - M).

  • Rightward shift indicates an increase in aggregate demand; leftward shift indicates a decrease.

Aggregate Demand Curve Shifters

1. Consumer Spending (C)

• Rightward Shift: Increased consumer confidence, disposable income, transfer payments, or decreased taxes.

• Leftward Shift: Decreased consumer confidence, disposable income, transfer payments, or increased taxes.

2. Gross Investment (I)

• Rightward Shift: Increased business confidence, investment, or decreased interest rates.

• Leftward Shift: Decreased business confidence, investment, or increased interest rates.

3. Government Purchases (G)

• Rightward Shift: Government increases buying of goods and services.

• Leftward Shift: Government decreases buying of goods and services.

4. Net Exports (X - M)

• Rightward Shift: Increase in exports; impacts by tastes, preferences, domestic and foreign price levels, national income, and exchange rates.

• Leftward Shift: Increase in imports decreases net exports.

Conclusion

• Introduction to aggregate demand is foundational for understanding macroeconomic principles.

• Future lessons will delve deeper into aggregate demand topics.

• Practice resources available, including the Total Review Booklet for comprehensive study.