What is Aggregate Demand
The aggregate demand curve shows the relationship between the aggregate price level and the quantity of aggregate output demanded by households, business, the government and the rest of the world
Aggregate output and real GDP can be used interchangeably
All things equal, a movement down the AD curve leads to a lower aggregate price level and higher aggregate output, and vice versa
Recall the basic equation of national income accounting
- Y = C + I + G + NX
Why is the AD Downward Sloping?
Demand Curve vs. Aggregate Demand Curve
If the demand for one product is downward sloping, wouldn’t the aggregate demand also do the same?
The demand curve for an individual good assumes that you hold price of other goods constant
For the aggregate demand, there is a simultaneous change in the price of all final goods and services!
If the price of gas goes up, and people buy more econ textbooks, it doesn't necessarily change anything at all.
So then, why does a rise in the aggregate price level lead to a fell in the quantity of all domestically produced final goods and services produces?
change in consumer spending caused by the altered purchasing power of consumer's assets
An increase in the aggregate price level means people are relatively poorer, and vice versa
Thus, consumer spending or C, changes and you move up and down the AD curve
Interest Rate Effect
change in investment and consumer spending caused by interest rates that result from changes in demand for money
With a higher aggregate price level, causes an increase in money holdings which reduces funds available for borrowing
Interest rate increase and consumer spending, C, and investment spending, I decreases
Shift in the Aggregate Demand Curve
Changes in Expectations
Consumers base spending on future income
If the Conference Board, or Michigan Consumer Sentiment Index reports an increase in consumer confidence, AD has increased
Changes in Wealth
People with more wealth will tend to spend more
If the stock market crashes or real estate values plummet, the AD shifts to the left
Size of the Existing Stock of Physical Capital
If the inventory of housing is high, the AD will shift left
If inventory is low, then AD will shift to the right
Fiscal Policy (use of taxes and government spending)
Expansionary fiscal policy
- Increase in Government spending or decrease in taxes will shift AD to the right
Contractionary fiscal policy
- Decrease in Government spending or increase in taxes will shift AD to the left
Monetary Policy (central bank's or Fed's use of changes in quantity of money or interest rates)
Expansionary monetary policy
- If the Fed increase the money supply (lowered interest rates), then AD increases
Contractionary monetary policy
- If the Fed decrease the money supply (higher interest rates), then AD decreases