Aggregate Demand Curve Notes

Overview of the Aggregate-Demand Curve

• The aggregate demand (AD) curve shows the total demand for goods and services in an economy at different price levels.

• It is represented by the equation: Y = C + I + G + NX, where:

  • Y = Aggregate demand

  • C = Consumption (what households spend)

  • I = Investment (what businesses invest)

  • G = Government spending

  • NX = Net exports (exports minus imports)

Why the AD Curve Slopes Downward

1. Wealth Effect (C)

   • When prices go down, people feel richer because their money can buy more.

   • This makes them spend more, increasing demand for goods and services.

2. Interest-Rate Effect (I)

   • Lower prices mean less money is needed for transactions, leading to lower interest rates.

   • Lower interest rates make borrowing cheaper, encouraging businesses to invest and consumers to buy new homes.

3. Exchange-Rate Effect (NX)

   • With lower prices, interest rates drop, causing the value of the currency to fall.

   • A weaker currency makes domestic goods cheaper for foreign buyers, increasing net exports and overall demand.

Summary of Effects of Decreasing Price Level

• Increased Quantity Demanded:

  • Consumers spend more due to feeling wealthier (Wealth Effect).

  • Lower interest rates increase business investments (Interest-Rate Effect).

  • Currency depreciation raises net exports (Exchange-Rate Effect).

Effects of Increasing Price Level

• Higher prices reduce purchasing power, making consumers spend less.

• Higher interest rates discourage investments.

• A stronger currency can decrease net exports.

• Overall, this leads to a decrease in demand for goods and services.

Factors Leading to Shifts in the AD Curve

1. Changes in Consumption (C)

   • Tax cuts increase spending; tax hikes decrease it, causing right or left shifts in the AD curve.

2. Changes in Investment (I)

   • Positive business outlook or lower interest rates boost investment (right shift); pessimism or higher rates reduce it (left shift).

3. Changes in Government Purchases (G)

   • Increased government spending boosts demand (right shift); cuts in spending lower demand (left shift).

4. Changes in Net Exports (NX)

   • Global economic conditions can affect exports; a booming foreign economy increases demand (right shift); a recession decreases it (left shift).

Conclusion

• Understanding how the AD curve works helps analyze economic changes. Factors like consumption, investment, government spending, and net exports are key to shifting the aggregate demand curve.