AGGREGATE DEMAND Aggregate Supply CHAPTER OUTCOMES Differentiate between the aggregate demand and aggregate supply curves Identify the determinants of aggregate demand and aggregate supply Describe how the long run aggregate supply curve operates AGGREGATE DEMAND The schedule of the amount of goods and services i e real output that domestic consumers business government and foreign buyers desire to purchase at each possible price level C I G NX AGGREGATE DEMAND Inverse or negative relationship the lower the price level the larger the real GDP these buyers will purchase and vice versa AGGREGATE DEMAND Aggregate demand shows the relationship between the aggregate quantity demanded and the price level Downward sloping QUANTITY OF REAL GDP DEMANDED Total amount of final goods and services produced in the US that people business government and foreigners plan to buy AGGREGATE DEMAND Wealth effect A rise in the price level other things remaining the same decreases the quantity of real wealth money bonds stocks etc To restore their real wealth people increase saving and decrease spending so the quantity of real GDP demanded decreases Similarly a fall in the price level other things remaining the same increases the quantity of real wealth With more real wealth people decrease saving and increase spending so the quantity of real GDP demanded increases REAL WEALTH Is the amount of money in the bank bonds stocks and other assets that people own measured in terms of goods and services that the wealth will buy Measured by the amount of goods and services your wealth buys AGGREGATE DEMAND SCHEDULE Slopes downward because of wealth effect interest rate effect tendency for increases in price level to increase the demand for money raise interest rates and as a result to reduce total spending in the economy AGGREGATE DEMAND SCHEDULE Interest rate effect assumes supply of money is fixed therefore higher price level increases demand for money increasing price paid for its use higher price level reduces amount of real output demanded investment goods Credit made more expensive AGGREGATE DEMAND SCHEDULE Slopes downward because of wealth effect interest rate effect Foreign trade effect the inverse relationship between net exports and price level relative to foreign price levels AGGREGATE DEMAND SCHEDULE Foreign trade effect relative increase in nation s price level reduces net exports resulting in decline in aggregate amount of domestic output demanded and vice versa AGGREGATE DEMAND SCHEDULE Foreign trade effect US goods become more expensive relative to foreign goods causing US consumers to substitute imported goods for domestic goods Decreases US exports demanded AGGREGATE DEMAND SCHEDULE Slopes downward because of Real wealth effect Real interest rate effect Foreign trade Substitution effect Intertemporal International AGGREGATE DEMAND Intertemporal substitution effect A rise in the price level other things remaining the same decreases the real value of money and raises the interest rate Faced with a higher interest rate people try to borrow and spend less so the quantity of real GDP demanded decreases Similarly a fall in the price level increases the real value of money and lowers the interest rate Faced with a lower interest rate people borrow and spend more so the quantity of real GDP demanded increases AGGREGATE DEMAND International substitution effect A rise in the price level other things remaining the same increases the price of domestic goods relative to foreign goods so imports increase and exports decrease which decreases the quantity of real GDP demanded Similarly a fall in the price level other things remaining the same decreases the price of domestic goods relative to foreign goods so imports decrease and exports increase which increases the quantity of real GDP demanded CHANGE IN AGGREGATE DEMAND Change in amount of nation s final products that will be purchased caused by something other than the price level changing DETERMINANTS OF AGGREGATE DEMAND Cause change in aggregate demand shift of entire schedule AGGREGATE DEMAND Figure 23 7 When aggregate illustrates changes in aggregate demand demand increases the AD curve shifts rightward and when aggregate demand decreases the AD curve shifts leftward DETERMINANTS OF AGGREGATE DEMAND 1 Change in consumer spending consumer wealth all consumer assets including financial and physical assets decline in real value of consumer assets encourage more savings and less purchases to restore wealth decreasing aggregate demand curves shifts leftward DETERMINANTS OF AGGREGATE DEMAND 1 Change in consumer spending consumer wealth consumer expectations confidence when people expect future incomes to rise they spend more of their current incomes increasing aggregate demand shifts curve to right DETERMINANTS OF AGGREGATE DEMAND 1 Change in consumer spending consumer wealth consumer expectations consumer indebtedness high debt may force cut in present spending to pay off debt curve shifts to left DETERMINANTS OF AGGREGATE DEMAND 1 Change in consumer spending consumer wealth consumer expectations consumer indebtedness taxes cut increases Disposable Personal Income curve shifts to right DETERMINANTS OF AGGREGATE DEMAND 1 Change in consumer spending 2 Change in investment spending purchase of capital goods interest rates because of change in money supply increase in money supply reduces interest rate increasing aggregate demand curve shifts to right DETERMINANTS OF AGGREGATE DEMAND 1 Change in consumer spending 2 Change in investment spending interest rates profit expectations on investment projects higher expected returns increase demand for capital goods shifts aggregate demand curve to right DETERMINANTS OF AGGREGATE DEMAND 1 Change in consumer spending 2 Change in investment spending interest rates profit expectations on investment projects business taxes increase reduces profits investment spending and aggregate demand DETERMINANTS OF AGGREGATE DEMAND 1 Change in consumer spending 2 Change in investment spending real interest rates profit expectations on investment projects business taxes technology may stimulate investment spending and thus aggregate demand DETERMINANTS OF AGGREGATE DEMAND 1 Change in consumer spending 2 Change in investment spending real interest rates profit expectations on investment projects business taxes technology degree of excess capacity increase retards demand for new capital goods reducing aggregate demand DETERMINANTS OF