Aggregate Demand Chapter 11one week Aggregate Demand n

Aggregate Demand Chapter 11—one week

Aggregate Demand n Aggregate demand is NOT demand (reminder: single product—P and Q--the curve is downward sloping because people will demand more at a lower price)

Is a schedule that shows the amounts of real domestic output, GDP and Price Level n Example on page 204, figure 11. 1 n Shows an inverse relationship between price level and domestic output n The explanation of the inverse relationship is not the same as for demand for a single product n ¨ Substitution effect doesn’t apply in the aggregate case, since there is no substitute for “everything”

Explanation of Inverse Relationship n Real Balance Effect or Wealth Effect ¨ As the price level falls, cash balances will buy more so people will spend more, thus increasing real output.

n Interest-Rate Effect ¨ Decrease in plans to buy capital and durables because a PL increase will decrease the interest rate. ¨ A PL increase decreases the purchasing power of $ ¨ A decline in PL means lower interest rates which can increase levels of certain types of spending (Ig)

n Foreign Purchases Effect or Net Export Effect ¨ when price level falls, other things being equal, US prices will fall relative to foreign prices, which will tend to increase spending on US exports and also decrease import spending in favor of US products that compete with imports

Determinants of A. D. n The “other things” (besides price level) that can cause a shift or change in demand (see page 206)

n 1. Changes in consumer spending (C), which can be caused by: ¨ A. Consumer wealth – “Wealth Effect” of income (liquidity, inflation and “real” income ¨ B. Future expectations of wages and wealth ¨ C. Levels of indebtedness and response to more purchases ¨ D. Net income after tax payments

n 2. Changes in investment spending (Ig), which can be caused by: ¨ A. Interest rates or the cost of borrowing ¨ B. Future profit expectations ¨ C. Profit after taxes ¨ D. Available technology and time to adjust to technology ¨ E. Amount of unused capital

n 3. Change in gov’t spending (G) ¨ Spending n on G and S 4. Changes in net exports (Xn) unrelated to PL, which may be caused by: ¨ Income abroad ¨ Exchange rates n Depreciation of the dollar encourages US exports § and discourages import buying

What shifts the A. D. Curve? PL AD 2 AD AD 3 Real GDP

n Determine whether each situation will cause an increase, decrease or no change in AD. Always start with AD. If the situation would cause an increase in AD, draw an in column 1. If there is a decrease in AD, draw a . If there is no change, write NC. For each situation that causes a change in AD, write the number of the new demand curve in column 2. Move only one curve.

Situation 1. Congress cuts taxes 2. Gov’t spending to increase next year; president promises no increase in taxes 3. Survey shows consumer confidence jumps 4. Stock market collapses; investors lose billions 5. Productivity rises for the 4 th year 6. President cuts defense spending by 20%; no increase in domestic spending change in AD↑ ↓ Determinate

Situation 1. Congress cuts taxes change in AD Determinate ↑ ↑ G G 3. Survey shows consumer confidence jumps ↑ C 4. Stock market collapses; investors lose billions ↓ C NC ↓ G 2. Gov’t spending to increase next year; president promises no increase in taxes 5. Productivity rises for the 4 th year 6. President cuts defense spending by 20%; no increase in domestic spending