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Aggregate Supply & Aggregate Demand Chapter 11-2 Aggregate Demand

Aggregate Supply & Aggregate Demand

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Aggregate Supply & Aggregate Demand. Chapter 11-2 Aggregate Demand. The AS/AD Model. The AS/AD model is fundamentally different from the microeconomic supply/demand model. The AS/AD Model. Microeconomic supply/demand curves concern the price and quantity of a single good. - PowerPoint PPT Presentation

Text of Aggregate Supply & Aggregate Demand

  • Aggregate Supply & Aggregate DemandChapter 11-2 Aggregate Demand

  • The AS/AD ModelThe AS/AD model is fundamentally different from the microeconomic supply/demand model.

  • The AS/AD ModelMicroeconomic supply/demand curves concern the price and quantity of a single good.Price of a single good is measured on the vertical axis and quantity of a single good is measured on the horizontal axis.The shapes are based on the concepts of substitution and opportunity cost.

  • The AS/AD ModelIn the AS/AD model the price of everything is on the vertical axis and aggregate output is on the horizontal axis.So there is no substitution

  • Aggregate DemandThe aggregate demand curve shows the relationship between the aggregate price level and the quantity of aggregate output demanded by households, businesses, and the government

  • The Aggregate Demand CurveThe aggregate demand (AD) curve shows how a change in the price level changes aggregate expenditures on all goods and services in an economy.It shows the level of expenditures that would take place at every price level in the economy.

  • The Slope of the AD CurveThe AD is a downward sloping curve.Aggregate demand is composed of the sum of aggregate expenditures.Expenditures = C + I + G +(X - M)

  • The Aggregate Demand CurveAggregate Demand is the total value of real GDP that all sectors of the economy (C + I + G + Xn) are willing to purchase at various price levels.

    When the price level increases, (inflation), people purchase less output.

  • Real Balance EffectYou feel poorer, so you spend less.Purchasing power declines with inflation. Interest Rate EffectRising prices push up interest rates. Lenders need higher interest rates to compensate for eroding purchasing power of money. Foreign Purchases EffectIf prices rise in the US, exports decrease and imports increase, so Xn decreases. Three Reasons why the AD CurveSlopes Down

  • The Aggregate Demand Curve

  • Downward Sloping It is downward-sloping for two reasons: The first is the Real Balance Effect of a change in the aggregate price levela higher aggregate price level reduces the purchasing power of households wealth and reduces consumer spending. The second is the interest rate effect of a change in aggregate the price levela higher aggregate price level reduces the purchasing power of households money holdings, leading to a rise in interest rates and a fall in investment spending and consumer spending

  • The Real Balance EffectReal Balance Effect a fall in the price level will make the holders of money and other financial assets richer, so they buy more.Most economists accept the logic of the wealth effect, however, they do not see the effect as strong.

  • The Interest Rate EffectInterest rate effect the effect a lower price level has on investment expenditures through the effect that a change in the price level has on interest rates.

  • The Interest Rate EffectThe interest rate effect works as follows:a decrease in the price level increase of real cash banks have more money to lend interest rates fall investment expenditures increase

  • Shift FactorsThe aggregate demand curve shifts because of Changes in expectationsChanges in wealthChanges in the stock of physical capital

    Policy makers can use fiscal policy and monetary policy to shift the aggregate demand curveNot in this chapter but will be in future chapters

  • Coming SoonIn the next few chapters you will see the following patterns

  • Government policies

    Fiscal policy Tax and/or government spending AD

    Monetary policy Federal Reserve money supply interest rates spending AD

  • Shifts of the Aggregate Demand Curve Rightward Shift

  • Shifts of the Aggregate Demand Curve Leftward Shift

  • Shifts in the AD CurveChange in total expenditures = 300Price levelReal outputAD0P0Initial effect = 100 increase in exportsMultipliereffect = 200

    **The aggregate demand curve shows the relationship between the aggregate price level and the quantity of aggregate output demanded. The curve is downward-sloping due to the wealth effect of a change in the aggregate price level and the interest rate effect of a change in the aggregate price level. Here, the total quantity of goods and services demanded at an aggregate price level of 8.9, the actual number for 1933, is $636 billion in 2000 dollars, the actual quantity of aggregate output demanded in 1933. According to our hypothetical curve, however, if the aggregate price level had been only 5.0, the quantity of aggregate output demanded would have been $950 billion.The effect of events that increase the quantity of aggregate output demanded at any given aggregate price level, such as improvements in business and consumer expectations or increased government spending. Such changes shift the aggregate demand curve to the right, from AD1 to AD2.

    The effect of events that decrease the quantity of aggregate output demanded at any given price level, such as a fall in wealth caused by a stock market decline. This shifts the aggregate demand curve leftward from AD1 to AD2.