1. The Aggregate Economy
LRAS
Price Level AS
PL1 AD Q1 FE
RGDP

2. The Aggregate Economy
Economic well being is determined by the level of Real GDP
The level of RGDP is determined by current levels of aggregate demand (AD) and aggregate supply (AS).
Since spending levels are more easily changed than production levels most macroeconomic policy focuses on aggregate demand.

3. Down Sloping Nature of AD
Price Level A r1 r2 B AD Q2 Q1
RGDP

4. Aggregate Demand slopes downward for reasons different than the demand curve for a single product
Product Demand
Income Effect
Substitution Effect
Aggregate Demand
Wealth Effect
Interest Rate Effect
Aggregate Demand differs from the demand curve for an individual item in that
an increase in overall price level does NOT diminish purchasing power because overall income is tied to overall price levels in the macroeconomy
when price levels increase there are no cheaper substitutes (all prices are rising)

5. The Aggregate Demand
The level of total spending in an economy is the most important determinant of GDP.
Aggregate demand is the total spending by all four sectors of our economy.
AD = Consumption + Investment + Government + Net Exports = GDP
Aggregate demand is determined by current price level and the current level of spending (Consumption, Investment, Government , Net Exports)

6. Aggregate Demand (AD) AD
A change in Price Level moves the economy along the AD curve.
A change in C , I , G or NX moves the location of the curve.
Price Level
AD2 AD
Real GDP

7. Determinants of Consumption
Consumption is a determinant of AD --A change in C causes a shift in the AD Curve
Consumption (C)
spending by households on goods and services
Determinants of Consumption
Disposable income (Yd) - income after taxes & transfer payments
Wealth (accumulated savings)
Expectations of income

8. Changes in Consumption
Any increase in C (consumption spending) will change AD (total spending).
If C increases then AD increases
The opposite is also true.
An increase in Consumption increases AD PL
AD1
AD2
RGDP

9. Investment Investment (I)
Spending by businesses on capital
Machinery, factories, technology, inventories
Investment Demand (I) is the quantity businesses want to spend within a given time period.
Determinants of Investment
Interest rates
Future level of GDP
Productive capacity

10. Changes in Investment
Any increase in Investment (business spending on capital) will change AD (total spending).
If I increases then AD increases
The opposite is also true.
An increase in Investment increases AD PL
AD1
AD2
RGDP

11. Adding Government
Government policies can have a powerful influence on aggregate demand
Government influences AD through fiscal and monetary policy
Fiscal Policy has two main components
Government spending – government purchases of goods and services and government transfer payments
A change in government spending has a direct effect because it is a component of AD. A decrease in spending shifts the curve left, an increase in spending shifts the curve right
Tax & transfer payment policies
Changes in tax policy & transfer payments influence the economy indirectly through changes in consumers’ disposable income. Increases in taxes decrease AD. Increases in transfers increases AD.

12. Adding Government
Monetary Policy involves the use of changes in the money supply and consequently changes in the interest rate to affect overall spending levels
An increase in the money supply gives households and firms more money, which they are then more willing to loan out. This decreases interest rates increasing consumption (C) and investment spending (I).
The opposite is also true.
An increase in Government spending or an increase in the money supply increases AD PL
AD1
AD2
RGDP

13. Net Exports Net Exports (exports – imports)
Determinants of Net Exports:
Income abroad (if foreign income is up our exports go up)
Exchange rates (if the dollar appreciates our exports go down)
Tariffs (if we place a tariff on imports our imports go down)
Net Exports (NX) goes up If exports go up or if imports go down
Net Exports (NX) goes down if exports go down or if imports go up.
An increase in NX leads to an increase in AD
A decrease in NX leads to a decrease in AD