Aggregate Demand

Supply and Demand Nationally  In microeconomics, supply and demand show just one industry (e.g., sodas, iPods, cell phones)  Macroeconomics is interested in entire economy  We can use the philosophies of supply and demand in aggregate to understand the whole economy  Analyzing AD and AS helps us analyze inflation, GDP, employment, and government policies

Aggregate Demand  Sum of all demands for all the goods and services in all final markets  Final markets are the “end” of the value chain: for the end consumer  AD is the sum of spending of consumers, investment, government, and net exports  AD = C + I + G + X - M

Graphing Aggregate Demand

AD Slopes Downward  Slope is same as for regular demand, but reasons are different (but related)  AD slopes downward because –Real Wealth Effect –Net Exports Effect –Interest Rate Effect

Real Wealth Effect  As prices rise, the real value of people’s savings falls  Example: $20 saved in 1970 will have lost value by 2010 due to inflation  As prices rise, people save more to maintain their saved value  If people save more, they spend less, so GDP falls

Net Export Effect  As prices rise in one’s country, imports seem cheaper  Example: as prices for California wines rise, Americans buy Chilean wines  As prices in general rise in one country, exports seem more expensive to other countries  Example: as prices in America rise, Europeans buy German software instead of American software  As net exports fall, GDP falls

Interest Rate Effect  As prices rise, interest rates tend to rise too (banks need to profit above inflation, so they raise interest rates on new loans)  With higher interest rates, consumers are less likely to borrow, and so are less likely to make large purchases, like houses and cars  Higher rates encourage savings, not spending  Higher rates discourage investment (companies are discouraged from borrowing to invest)  Higher rates discourage gov’t spending (currently governments borrow to spend, too)

Shifting AD  Any change to C, G, I, or X N  Common causes –Change in interest rates affect C, G, I, X N –Change in government spending (G) –Change in income taxes (change consumers’ disposable income, so changes spending) –Change in consumer confidence (e.g., terrorism, or fear of layoffs) –Stock market change, housing market change, affect consumer confidence and spending –Change in population