Price lvl = Y, Real GDP= X; There is an inverse relationship between X and Y.
AD is the demand by consumers, businesses, government, and foreign countries.
What definitely doesn’t shift the curve?
Changes in price level cause a move along the curve.
Why is AD downward sloping?
1. Real balance effect-
Higher price levels reduce the purchasing power of money
This decreases the quantity of expenditures
Lower price levels increase purchasing power and increase and expenditures
2. Interest Rate effect-
When the price level increases, lenders need to charge higher interest rates to get a REAL return on their loans.
Higher interest rates discourage consumer spending and business investment.
3. Foreign Trade Effect
When US price level rises, foreign buyers purchase fewer US goods and Americans buy more foreign goods.
Exports fall and imports rise, causing real GDP to fall. (Xn decreases)
Shifters of aggregate Demand: GDP= C+I+G+Xn
There are two parts to a shift in AD
A change in C, I, G, and/or Xn
A multiplier effect that produces a greater change than original change in 4 components
Increase in AD= AD->
Decrease in AD= <-AD
Determinants of AD-
Consumption
Household spending is affected by:
Consumer wealth. More wealth= more spending(AD ->), less wealth= less spending
Consumer Expectations. Positive expectations= more spending, Neg.= less spending
Household indebtedness. Less debt= more spending, more debt= less spending
Taxes. Less taxes, more spending, more taxes, less spending
Gross Private Domestic Investment
Investment spending is sensitive to:
Real Interest rate. Lower rate= more investment(AD->); higher Real interest rate= Less investment
Expected returns. Higher expected returns= More investment, Lower Expected returns= less investment
Influenced by-
Expectations of future profitability,
Tech
Degree of excess capacity(Existing stock of capital)
Business taxes
Net Exports
Sensitive to
Exchange rates. Strong $= more imports. less exports. (AD<). Weak$= Fewer imports, more exports (AD>)
Relative income. Strong foreign economies= more exports (AD>). Weak foreign economies= less imports (AD<)
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