Aggregate Demand

Aggregate Demand

3 Components create the Negative Slope Interest Rate Effect – As price level rises, so do interest rates. This means business buy less capital (invest less) and consumers buy fewer durable goods. When price level (and interest rate) drops businesses buy more capital (invest more) and consumers buy more durable goods Inverse relationship Wealth Effect- as price level increases the value of the dollar decreases – it takes more dollars to buy the same goods so purchasing power of that cash balance decreases. (real wealth) People and businesses decrease consumption and vice versa. (Real Balance Effect) Net Export Effect – when domestic price level increases (relative to foreign goods) domestic goods are more expensive for foreign consumers and foreign goods are cheaper for domestic consumers. So increase in price level = decrease in exports and an increase in imports. Both will decrease NX. And vice versa

Shifts in Aggregate Demand Non-Price Level Based Shift Factors Expectations- Economy then AD = right (expect higher future incomes or higher future prices) Economy then AD = left (expect lower future incomes and need for more savings) similar to induced investment phenomenon Foreign Income and Price Levels –income of foreign consumers affects their willingness to buy American exports & PL’s in their countries affect the value of American goods in comparison to their domestic goods. So: Foreign incomes = exports & AD Right & vice versa Foreign Price Levels = exports & AD Right & vice versa Government Policy – Fiscal policy decisions can affect AD both positively money supply, spending, taxes, interest rates = AD right money supply, spending, taxes, interest rates = AD left

Shifts in AD

Rates = increased investment Rates = decreased investment Investment Demand Rates = increased investment (cheap to borrow- not worth putting on deposit) Rates = decreased investment (expensive to borrow- worth putting on deposit)

As production increases in the economy, unemployment falls. Aggregate Supply 3 Distinct sections - very high unemploy. - "normal" unemploy. - very low unemploy. If real GDP then unemployment (it takes more people to produce a higher GDP = more people in production)   if real GDP then unemployment (it takes fewer people to produce a lower GDP) As production increases in the economy, unemployment falls. 

Aggregate Supply Curve High Unemployment –Lots o’ workers are available to increase GDP - they are unemployed and happy for the opportunity the work even at low wages so prices do not increase.  Output but the price level does not rise & AS curve is horizontal.  

AS @ Very High Unemployment

Normal Employment – (fewer people are unemployed ) Firms must offer higher wages to attract needed worker so wages increase which leads to price increases.  AS begins to show a positive slope

AS @ “Normal” Unemployment (SHORT RUN)

Very low unemployment As economy grows more and more people are employed, and @ some point a physical limit on the amount the economy can produce will be reached.  When this point is reached, AS becomes vertical.  Real GDP can no longer increase.  Only price increases are possible. 

AS @ Low Unemployment (LONG RUN)

SRAS & AD

Shifts in AD & SRAS