Aggregate Demand

Aggregate Demand - Shows amount of real GDP that the private, public and foreign a sector collectively desire to purchase at each possible price level

• The relationship between price level and level of real GDP is inverse

The Reason AD is Downward Sloping

• Real-Balances Effect
• When price level is high, households and businesses can not afford to purchase as much output
• When price level is low, households and businesses can afford to purchase more output 

• Interest-Rate Effect
• A higher price level increases interest rate, which tends to discourage investment
• A lower price level decreases interest rate, which tends to encourage investment 

• Foreign Purchases Effect
• Higher price level increases demand for relatively cheaper imports
• Lower price level increases foreign demand for cheaper US exports 

Shifts in Aggregate Demand

• There are two parts to a shift in AD:
• Change in C, Ig, G and Xn
• Multiplier effect that produces greater change than original change in the 4 components

• Increases in AD go right
• Decreases go left

Determinants of AD

Consumption

• Household spending is affected by:
• Consumer Wealth
• More wealth, more spending (AD increases)
• Less wealth, less spending (AD decreases)

• Consumer Expectations
• Positive expectations - more spending 
• Negative expectations - less spending 

• Household Indebtedness 
• Less debt, more spending 
• More debt, less spending 

• Taxes
• Less taxes, more spending
• More taxes, less spending 

Gross Private Investment

• Investment spending is sensitive to:
• The Real Interest Rate
• Lower interest rate, more investment (AD increases)
• Higher interest rate, less investment (AD decreases)

• Expected Returns
• Higher expected returns, more investment
• Lower expected returns, less investment 

• Expected returns are influenced by: 
• Expectations of future profitability
• Technology
• Degree of excess capacity (Existing Stock of Capital)
• Business Taxes

Government Spending

• More government spending, AD increases
• Less government spending, AD decreases

Net Exports

• Net Exports are sensitive to:
• Exchange Rates (International value of $)
• Strong $ = More imports and fewer exports (AD decreases)
• Weak $ = Fewer imports and more exports (AD increases) 

• Relative Income
• Strong foreign economies = more exports, AD increases
• Weak foreign economies = less exports, AD decreases