Mehdi Arzandeh, University of Manitoba PowerPoint Presentation by Mehdi Arzandeh, University of Manitoba

© 2016 McGraw‐Hill Education Limited Aggregate Demand and Aggregate Supply 12 Appendix to Chapter 12 LEARNING OBJECTIVES LOA12.1 Identify how the aggregate demand curve relates to the aggregate expenditures model. © 2016 McGraw‐Hill Education Limited

© 2016 McGraw‐Hill Education Limited The Relationship of the Aggregate Demand Curve to the Aggregate Expenditures Model A12.1 A change in the price level alters the location of the aggregate expenditures schedule through the real-balances, interest-rate, and foreign-trade effects. The aggregate demand curve can be derived from the aggregate expenditures model by allowing the price level to change and observing the effect on the aggregate expenditures schedule and thus on equilibrium GDP. LOA1 © 2016 McGraw‐Hill Education Limited

Aggregate Expenditures LO4.1 Deriving the Aggregate Demand Curve from the Expenditures Model FIGURE A12-1 AE1 (at P1 ) AE2 (at P2 ) 1 AE3 (at P3 ) 2 Aggregate Expenditures (billions of dollars) 3 LO1 LO1 LO1 45° In Figure A12-1 we are deriving the aggregate demand curve from the aggregate expenditures model. Both models measure real GDP on the horizontal axis. Suppose the initial price level is P1 and aggregate expenditures is AE1. Equilibrium real domestic output is Q1. There will be a corresponding point on the aggregate demand curve (Point 1). If price rises to P2, aggregate expenditures will fall to AE2 because purchasing power of wealth falls, interest rates may rise, and net exports fall. Then new equilibrium is at Q2. That generates a point (Point 2) up and to the left of Point 1. If price rises to P3, real asset balance value falls, interest rates rise again, net exports fall and new equilibrium is at Q3. This generates a point (Point 3). Technically, the aggregate demand curve is found by drawing a line (or curve) through Points 1, 2, and 3. P3 3 Price Level P2 2 1 P1 AD GDP3 GDP2 GDP1 Real Domestic Product, GDP LOA1 © 2016 McGraw‐Hill Education Limited

© 2016 McGraw‐Hill Education Limited LO4.1 Shifts in the Aggregate Expenditures Schedule and in the Aggregate Demand Curve FIGURE A12-2 AE2 (at P1 ) AE1 (at P1 ) Figure A12-2 shows shifts of the aggregate expenditures schedule and of the aggregate demand curve. When there is a change in one of the determinants of consumption, investment, or net exports, there will be a change in the aggregate expenditures as well. The change in aggregate expenditures is multiplied and aggregate demand shifts by more than the initial change in spending. The text illustrates the multiplier effect of a change in investment spending. Shift of AD curve = initial change in spending x multiplier. P1 AD2 AD1 GDP1 GDP2 LOA1 © 2016 McGraw‐Hill Education Limited

© 2016 McGraw‐Hill Education Limited Aggregate Demand Shifts and the Aggregate Expenditures Model A12.1 With the price level held constant, increases in consumption, investment, government, and net export expenditures shift the aggregate expenditures schedule upward and the aggregate demand curve to the right. Decreases in these spending components produce the opposite effects. LOA1 © 2016 McGraw‐Hill Education Limited

© 2016 McGraw‐Hill Education Limited APPENDIX Summary The aggregate demand curve is derived from the aggregate expenditures model by allowing the price level to change and observing the effect on the aggregate expenditures schedule and thus on equilibrium GDP. Shifts of the aggregate expenditure schedule will shift the aggregate demand curve. © 2016 McGraw‐Hill Education Limited