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Aggregate Demand
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a schedule or curve that shows the quantities of real domestic output (real GDP) that buyers (consumers, businesses, government, and foreigners) collectively want to purchase at various price levels (at each possible price level)
-ceteris paribus (domestic prices increase, so do prices of exports)
-ceteris paribus (domestic prices increase, so do prices of exports)
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Change in quantity of output demanded vs. a change in aggregate demand
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1. change in price level= change of quantity of aggregate demand
2. change in aggregate demand is caused by a change in aggregate demand shifter and change in position of curve
2. change in aggregate demand is caused by a change in aggregate demand shifter and change in position of curve
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Factors that shift (or change) Aggregate Demand
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determinants of aggregate Demand (refer to GDP formula)
1. Consumer Spending
2. Investment Spending
1. Consumer Spending
2. Investment Spending
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Aggregate Demand Shifter: Consumer Spending
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a. Consumer Wealth
b. Household Borrowing
c. Personal (HH) Expectations
d. Personal (HH) Taxes
b. Household Borrowing
c. Personal (HH) Expectations
d. Personal (HH) Taxes
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Consumer Spending: Consumer Wealth
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real value of financial assets increases, then consumers will feel wealthier spend more and the AD increases. If it falls, consumers will spend less and AD decreases
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Consumer Spending: Household Borrowing
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if consumers have high level of debt, may reduce spending leading to decrease in AD. If debt falls to a more manageable level, may borrow more money and increase their spending, increasing AD
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Consumer Spending: Personal Expectations
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if optimistic about future, will spend more leading to increase in AD. If pessimistic and do not spend, lead to decrease in AD
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Consumer Spending: Personal Taxes
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cuts in taxes increase disposable income and capacity for consumer spending, thus increasing AD. A rise in taxes decreases disposable income, consumer spending, and AD
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Aggregate Demand Shifter: Investment Spending
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can increase or decrease AD. If price level is constant and businesses decide to spend more on investment, then AD will increase. If businesses decide to spend less on investment then AD will decrease.
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Two Influential Factors for Investment Spending
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1. Real Interest Rates
2. Expected Returns
2. Expected Returns
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Investment Spending: Real Interest Rates
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-a decrease in real interest rates will increase the quantity of investment spending, increasing AD
-increase in real interest rates will decrease the quantity of investment spending, thus decreasing AD
-increase in real interest rates will decrease the quantity of investment spending, thus decreasing AD
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Investment Spending: Expected Returns
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1. expected future business with higher returns, likely increase their investment spending, AD will increase.
2. business expected lower returns, likely decrease their investment spending and AD will decrease
2. business expected lower returns, likely decrease their investment spending and AD will decrease
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Investment Spending
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-the purchase of capital goods, stands as the second factor to shift Aggregate Demand
-is a marginal-benefit vs. marginal-cost decision
-is a marginal-benefit vs. marginal-cost decision
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Influences of Expected Returns (Investment Spending)
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1. Technology (if it increase, Ig and AD increase)
2, Degree of Excess Capacity (amount of unused capital goods) (if it increase, Ig and AD decrease)
3. Business Taxes (if taxes go up, Ig and AD decrease, if taxes go down, Ig and AD increase)
2, Degree of Excess Capacity (amount of unused capital goods) (if it increase, Ig and AD decrease)
3. Business Taxes (if taxes go up, Ig and AD decrease, if taxes go down, Ig and AD increase)
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Government Spending (ceteris paribus)
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-direct effect on AD since tax collections and interest rates do not change as a result of spending
-more government spends increases AD, spends less decreases AD
-more government spends increases AD, spends less decreases AD
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Net Exports (triangleXn)
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-Increase in Xn happens when increase in exports and no change in imports
-increase in exports and decrease in imports
-increase in exports and decrease in imports
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Xn: National Income Abroad
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increase in National Income Abroad equals increase in exports (more money to spend)
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Xn: Change of Exchange Rates
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Exchange Rate: price of foreign currency in terms of domestic currency. Price of euro in American currency
example: if American money is less valued, it costs more American to buy euros and foreign goods. Foreign goods more expensive in American money terms leading to decrease in imports and increase in net exports leading to increase in AD
(continued): US goods less expensive to foreigners leads to increase in exports and increase in net exports and increase in AD
example: if American money is less valued, it costs more American to buy euros and foreign goods. Foreign goods more expensive in American money terms leading to decrease in imports and increase in net exports leading to increase in AD
(continued): US goods less expensive to foreigners leads to increase in exports and increase in net exports and increase in AD
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Xn: Tariffs
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decreae foreign tariffs leads to increase in Xn and increase in AD
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Aggregate Supply
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a schedule or curve showing the total quantities of real domestic output (real GDP) produced (supplied) at various price levels
ceteris paribus
ceteris paribus
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Aggregate Supply Curve
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1. Immediate Short Run: period of time during which both input and output prices are fixed (inflation)
2. Short Run: period of time during which input pices are fixed (inflexible) but output prices can vary (most important period)
3. Long Run: period of time long enough that both input and output prices are flexible
2. Short Run: period of time during which input pices are fixed (inflexible) but output prices can vary (most important period)
3. Long Run: period of time long enough that both input and output prices are flexible
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Per Unit Cost of Production Formula
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total input cost ÷ # of units
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Changes in Aggregate Supply
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1. Change of input prices
2. Changes in Productivity
3. Legal & Institutional Environment
2. Changes in Productivity
3. Legal & Institutional Environment
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Changes in A.S. : Changes of Input Prices
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a. Domestic input (labor, capitol, land, entreprenueral ability) prices increase would cause A.S. to decrease. If prices decrease than AS increases
b. Prices of Imported Resources (ex. increase in oil=decrease in AS)
-change of exchange rates can effect input prices as well
b. Prices of Imported Resources (ex. increase in oil=decrease in AS)
-change of exchange rates can effect input prices as well
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Changes in A.S. : Changes in Productivity
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- total outputs ÷ total inputs
- increase in productivity equals decrease in PUCP = increase in AS
- increase in productivity equals decrease in PUCP = increase in AS
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Determinants of Aggregate Supply
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Change per unit cost of production -> change in Aggregate Supply
If PUCP increases, AS decreases, if PUCP decreases, AS increases
If PUCP increases, AS decreases, if PUCP decreases, AS increases
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Equilibrium Price Level + Real GDP
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1. Demand Pull Inflation vs. Cost Push Inflation
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Demand Pull Inflation
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-too much money on few goods
-increase total spending = increase AD decrease AD
-increase total spending = increase AD decrease AD
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Cost Push Inflation
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-A decrease in A.S. would result in an increase in the price level and a decrease in real domestic output
- Increase PUCP = decrease AS
- Decrease PUCP = increase AS
- Increase PUCP = decrease AS
- Decrease PUCP = increase AS
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Downward Price Trend Inflexibility
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Ratchel Effect: In US economy, prive level rises but rarely falls due to
1. fear of price of war
2. menu costs
3. wage contracts
4. moral concerns
5. minimum wage
1. fear of price of war
2. menu costs
3. wage contracts
4. moral concerns
5. minimum wage
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Multiplier Effect
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- a small change in (total) aggregate spending can cause a bigger change in equilibrium GDP
- multiplied: change in equilibrium GDP (change in real GDP) ÷ initial change in aggregate spending
-change in real GDP = multiplied ÷ x initial
- multiplied: change in equilibrium GDP (change in real GDP) ÷ initial change in aggregate spending
-change in real GDP = multiplied ÷ x initial
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Self Correction
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- some studies suggest that wages and prices are becoming more flexible--downward
- if input prices (wages) decrease, it leads to decrease in PUCP and possibly an increase in AS
-automatic self correction (through time and patience)
- if input prices (wages) decrease, it leads to decrease in PUCP and possibly an increase in AS
-automatic self correction (through time and patience)
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