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9.1 Aggregate demand and the aggregate demand curve

Aggregate demand represents the total quantity of real GDP that all buyers in an economy wish to purchase at various price levels, illustrated by the downward-sloping aggregate demand curve. Shifts in this curve can occur due to changes in consumer confidence, interest rates, wealth, taxes, and other factors affecting consumption, investment, government spending, and net exports. Understanding these determinants is crucial for analyzing economic fluctuations and the overall health of an economy.

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6 views

9.1 Aggregate demand and the aggregate demand curve

Aggregate demand represents the total quantity of real GDP that all buyers in an economy wish to purchase at various price levels, illustrated by the downward-sloping aggregate demand curve. Shifts in this curve can occur due to changes in consumer confidence, interest rates, wealth, taxes, and other factors affecting consumption, investment, government spending, and net exports. Understanding these determinants is crucial for analyzing economic fluctuations and the overall health of an economy.

Uploaded by

helene.m.falk
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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9.

1 Aggregate demand and the aggregate


demand curve
Explaining aggregate demand and the aggregate demand curve
Aggregate demand: total quantity of aggregate output, or real GDP, that all buyers in an
economy want to buy at different possible price levels, ceteris paribus.
Aggregate demand curve shows the relationship between the aggregate output buyers
want to buy, or real GDP demanded, and the economy's price level, ceteris paribus.

The horizontal axis measures aggregate output, or real GDP, and the vertical axis measures
the general price level in the economy, which is an average over the prices of all goods and
services.

The aggregate demand curve

Shifts in the aggregate demand curve

Aggregate demand is the total amount of real output (Real GDP) that consumers, firms, the
government, and foreigners want to buy at each possible price level, over a particular time period.
The aggregate demand (AD) curve shows the relationship between the total amount of real output
demanded by the four components and the economy's price level over a particular time period. It
is downward sloping, indicating a negative relationship between the price level and aggregate
output demanded.

The determinants of aggregate demand (shifts in the AD curve)

Movements along the aggregate demand curve is caused by changes in the price levels.
Shifts of the aggregate demand curve is cause by the determinants of aggregate demand.
Rightward shift from AD1 to AD2: aggregate demand increases -> for any price level, a larger
amount of real GDP is demanded.
Leftward shift from AD1 to AD3: aggregate demand decreases > for any price level, a smaller
amount of real GDP is demanded.

Aggregate demand is composed of consumer spending, investment spending, government


spending and net export spending. Changes in aggregate demand and shifts in the aggregate
demand curve can be caused by any factor that produces a change in one of these four
components.

Causes of changes in consumption spending:

 Changes in consumer confidence: how optimistic consumers are about their future
income and the future economy? If consumers are optimistic about their future, they
are likely to spend more on buying goods and services, and the AD curve shifts to the
right.

 Changes in interest rates: An increase in interest rates makes borrowing more


expensive, resulting in lower consumer spending, and therefore a leftward shift in
the AD curve.

 Changes in wealth: An increase in consumer wealth makes people feel wealthier;


therefore, they spend more, and the AD curve shifts to the right.

 Changes in income taxes: If the government increases income taxes, then consumer
disposable income falls; therefore, spending drops, and the AD curve shifts to the
left.

 Changes in the level of household indebtedness: If consumers have high level of


debt, then they are under pressure to make high monthly payments to pay back
their loans plus interest, and so they are likely to cut back on their present
expenditure and shifts the AD curve to the left (lowers consumer spending).

 Expectations of future price levels: If consumers expect prices of goods and services
to fall, they may postpone spending as they wait for prices to fall, causing AD to
decrease, shifting AD to the left.
Causes of changes in investment spending:

 Changes in business confidence: how optimistic firms are about their future sales
and economic activity. If businesses are optimistic, they spend more on investment
and the AD curve shifts to the right.

 Changes in interest rates: Increase in interest rates will reduce investment spending
financed by borrowing and shift the AD curve left.

 Changes (improvements) in technology: Stimulate investment spending, thus causing


increases in aggregate demand and a rightward shift in the AD curve.

 Changes in business taxes: If the government increases taxes on profits of businesses


(fiscal policy), firms after tax profits fall; therefore, investment spending decreases
and the AD curve shifts to the left.

 The level of corporate indebtedness: If businesses have high levels of debt due to
past borrowing, they will be less willing to make investments and the AD curve shifts
to the left.

 Legal/institutional changes

Causes in government spending :

 Changes in political priorities: the government may decide to increase or decrease its
expenditures in response to changes in its priorities. Increase government spending
shifts the AD curve to the right, and decreased government spending shifts it to the
left.
 Changes in economic priorities: deliberate efforts to influence aggregate demand
(fiscal policy)

Causes of changes in net exports (export spending minus import spending):

 Changes in national income abroad: Strong economic growth in foreign countries can
increase demand for exports from the home country, leading to higher net exports
therefore the AD curve shifts to the right.

 Changes in exchange rates: An exchange rate is the price of one country's currency in
terms of another country's currency. A depreciation of the domestic currency makes
exports cheaper for foreign buyers and imports more expensive for domestic
consumers, potentially increasing net exports.

 Changes in trade policies, or the level of trade protection: "Trade protection" refers
to restrictions to free international trade often imposed by governments. Tariff
reductions or trade agreements that lower barriers to trade can boost exports and
reduce import competition, potentially increasing net exports.

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