Aggregate Demand Introduction and Determinants Jeniffer Blanco Patricia

Aggregate Demand: Introduction and Determinants Jeniffer Blanco Patricia Padron Nataly Gonzalez Franchesca De Jesus

Aggregate Demand • Is the relationship between the quantity of real GDP demanded and the price level when all other influenced on expenditure plans remains the same. • Other things equal, a higher aggregate price level, the smaller the quantity of aggregate output demanded; A lower aggregate price level, the greater the quantity of aggregate output demanded.

Aggregate Curve • Aggregate curve is a curve that shows the relationship between the aggregate price level and the quantity of the aggregate output demanded by households, firms, the government, and the rest of the world. • We use real GDP to measure aggregate output and will often use the two terms interchangeably were the vertical axis shows the aggregate price level, measured by GDP deflator. • The aggregate demand curve is a downward slope indicating a negative relationship between the aggregate price level and the quantity of aggregate output demanded.

Why is the aggregate demand curve downward sloping? GDP = C + I + G + x – IM • C is consumer spending, I is investment spending, G is government purchases of goods and services, X is exports to other countries, and IM is imports. • When you add this up it represents the quantity of domestically produce final goods and services demanded during a given period. • The demand curve for any individual good shows how the quantity demanded depends on the price of that good, holding prices of other goods and services constant. • Main reason the quantity of a good demanded falls when the prices of that good rises is because people switch their consumption to other goods and services that have become relatively less expensive. • When a rise in the aggregate price level lead to fall in the quantity of domestically produced final goods and services demanded its because of either wealth effect or interest rate effect.

Wealth Effect • An increase in aggregate price level, reduces the purchasing power of many assets. • With loss in purchasing power, the owner of that bank account would scale back his or her consumption plan. Million of people would react the same way, leading to a fall in spending on final goods and services. *Ex: Someone has $5, 000 dollars in a bank account, if the aggregate price level were to rise by 25% that 5, 000 would only buy you as much as $4, 000. Interest Rate Effect • An increase in aggregate price level, reduces the purchasing power of a given amount of money holdings. Which lead to a downwardsloping in the aggregate demand curve.

Shifts of the Aggregate Demand Curve -Movement of the aggregate curve: change in the aggregate quantity of goods and services demanded aggregate price level changes. -Shift of the aggregate curve: change in the aggregate quantity of goods and services demanded at any level. - An increase in aggregate demand means a shift to the right of the demand curve, occurs when the quantity output demanded increases at any given aggregegate price level. - A decrease in aggregate demands means the a shift to the left of the demand curve, occurs when the quantity of aggregate output demanded falls at any given aggregate price level. Factors that can shift the aggregate demand curve: Changes in expectations Changes in wealth Size of existing stock of physical capital Fiscal and monetary policy -By causing a rise or fall in GDP, they change disposable income leading to change in aggregate spending, leading to change in real GDP

Changes in expectations: -Consumer spending and planned investment depends on people’s expectations for the future. (Income they have now and what they think they’ll have in the future) -If consumers and firms are optimistic of their income, aggregate spending rises. If consumers and firms are pessimistic, aggregate spending falls. Changes in wealth: -Consumer spending depends on the value of the household. -When the real value of household assets rises, aggregate demand increases. When the real value of household assets falls, aggregate demand decrease. Size of the Existing Stock of Physical Capital: Firms use planned investment spending to add to their stock of physical capital. Their decisions depend on how much they have. If their existing stock of physical capital is small, aggregate demand increases. If their existing stock of physical capital is large, aggregate demand decreases.

Government Policies and Aggregate Demand -Government can have a powerful influence on Aggregate demand in two ways: 1. Fiscal policy 2. Monetary policy -In certain cases these policies can be used to improve economic conditions.

Fiscal Policy -Fiscal policy is the use of taxes, government transfers, or purchases of goods and services to stabilize the economy. -Fiscal policy is basically government intervention to help regulate or improve the economy. -Government intervention has a direct effect on the aggregate demand curve. -Government’s initial responses to a recession are to increase spending and/or cutting taxes. -An Increase in government spending will cause the curve to shift to the right and a decrease in spending will cause a shift to the left. -In turn, they often respond to inflation by reducing spending and increasing taxes. -A change in taxes will indirectly affect the economy because this is one of the determining factors of disposable income. -Fiscal policies have its benefits and its downfalls.

Monetary Policy -The Federal Reserve controls monetary policies. -The Federal Reserve is the U. S central bank which is not entirely owned by the government nor is it a private bank. -Monetary policy is the central banks use of changes in the quantity of money or the interest rate to stabilize and re-organize the economy. -The amount of money circulating the economy is determined by the central bank also known as the “Federal Reserve”. -When the Federal Reserve increases the money that is circulating the economy it results in higher investment and higher consumer spending. -When the Federal Reserve decrease the quantity of money circulating the economy it will result in less investment spending and consumer spending because households and firms will need to borrow more money and have less money to lend out.