Aggregate Demand in Macroeconomics
The Aggregate Economy
Price Level
AD
AS
RGDP
LRAS
FE
Q1
PL1
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
.
Price Level
RGDP
AD
r
1
Q
1
Q
2
Down Sloping Nature of AD
r
2
A
B
Aggregate Demand slopes downward for reasons
different than the demand curve for a single
product
Aggregate Demand differs from the demand curve for an
individual item in that
1.
an increase in overall price level does NOT diminish
purchasing power because overall income is tied to overall
price levels in the macroeconomy
2.
when price levels increase there are no cheaper
substitutes (all prices are rising)
A
g
g
r
e
g
a
t
e
D
e
m
a
n
d
•
Wealth Effect
•
Interest Rate Effect
P
r
o
d
u
c
t
D
e
m
a
n
d
•
Income Effect
•
Substitution Effect
The Aggregate Demand
•
The level of total spending in an economy
is the most important determinant of GDP.
–
A
g
g
r
e
g
a
t
e
d
e
m
a
n
d
i
s
t
h
e
t
o
t
a
l
s
p
e
n
d
i
n
g
b
y
a
l
l
f
o
u
r
s
e
c
t
o
r
s
o
f
o
u
r
e
c
o
n
o
m
y
.
AD = Consumption + Investment + Government +
Net Exports = GDP
–
A
g
g
r
e
g
a
t
e
d
e
m
a
n
d
i
s
d
e
t
e
r
m
i
n
e
d
b
y
c
u
r
r
e
n
t
p
r
i
c
e
l
e
v
e
l
a
n
d
t
h
e
c
u
r
r
e
n
t
l
e
v
e
l
o
f
s
p
e
n
d
i
n
g
(
C
o
n
s
u
m
p
t
i
o
n
,
I
n
v
e
s
t
m
e
n
t
,
G
o
v
e
r
n
m
e
n
t
,
N
e
t
E
x
p
o
r
t
s
)
A
g
g
r
e
g
a
t
e
D
e
m
a
n
d
(
A
D
)
R
e
a
l
G
D
P
P
r
i
c
e
L
e
v
e
l
A
D
A
c
h
a
n
g
e
i
n
P
r
i
c
e
L
e
v
e
l
m
o
v
e
s
t
h
e
e
c
o
n
o
m
y
a
l
o
n
g
t
h
e
A
D
c
u
r
v
e
.
A
c
h
a
n
g
e
i
n
C
,
I
,
G
o
r
N
X
m
o
v
e
s
t
h
e
l
o
c
a
t
i
o
n
o
f
t
h
e
c
u
r
v
e
.
A
D
A
D
2
C
o
n
s
u
m
p
t
i
o
n
i
s
a
d
e
t
e
r
m
i
n
a
n
t
o
f
A
D
-
-
A
c
h
a
n
g
e
i
n
C
c
a
u
s
e
s
a
s
h
i
f
t
i
n
t
h
e
A
D
C
u
r
v
e
•
C
o
n
s
u
m
p
t
i
o
n
(
C
)
–
spending by households on goods and
services
•
D
e
t
e
r
m
i
n
a
n
t
s
o
f
C
o
n
s
u
m
p
t
i
o
n
–
Disposable income
(Yd) - income after taxes &
transfer payments
–
Wealth (accumulated savings)
–
Expectations of income
Changes in Consumption
•
A
n
y
i
n
c
r
e
a
s
e
i
n
C
(
c
o
n
s
u
m
p
t
i
o
n
s
p
e
n
d
i
n
g
)
w
i
l
l
c
h
a
n
g
e
A
D
(
t
o
t
a
l
s
p
e
n
d
i
n
g
)
.
–
If C increases then AD increases
–
The opposite is also true.
RGDP
AD
1
PL
AD
2
An increase in Consumption
increases AD
D
i
s
p
o
s
a
b
l
e
I
n
c
o
m
e
(
D
I
)
o
r
(
Y
d
)
•
Disposable income is the income available after
taxes.
–
All income can either be
spent
or
saved
.
–
The
higher
your
income
the
more you spend and
save
and vice versa.
T
a
x
e
s
c
o
m
e
o
u
t
o
f
p
e
r
s
o
n
a
l
i
n
c
o
m
e
a
n
d
t
h
u
s
a
f
f
e
c
t
y
o
u
r
d
i
s
p
o
s
a
b
l
e
i
n
c
o
m
e
–
Personal income – taxes = disposable income =
spending + saving
–
An increase in taxes reduces both spending and
saving and vice versa.
Disposable Income and
Autonomous Consumption
•
There is
a constant level of Consumption
across all levels of disposable income.
•
I
f
i
n
c
o
m
e
f
a
l
l
s
t
o
z
e
r
o
C
o
n
s
u
m
p
t
i
o
n
d
o
e
s
n
o
t
b
e
c
o
m
e
z
e
r
o
.
•
Savings become negative because
households either
use past savings or
borrow
.
Wealth
•
Wealth is the
accumulation of
savings
.
•
It can take the form of financial assets or
real assets.
(Changes in stock or real estate prices
will affect your wealth & your spending habits).
•
The
greater your present wealth
the less
you have to save,
increasing consumption
.
Expectations of Future Income or
Prices
•
If you expect a raise in the near future you
will spend more now and vice versa.
•
If you think prices will rise in the near
future you will spend more now and vice
versa.
Debt
•
Debt is what is owed on previous
spending.
•
The more I owe the less I can spend now
.
•
Debt accumulation is seen as
an increase
in consumption
and a decrease in savings.
•
Debt reduction is seen as
a decrease in
consumption
and an increase in savings.
Investment
•
I
n
v
e
s
t
m
e
n
t
(
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
Changes in Investment
•
A
n
y
i
n
c
r
e
a
s
e
i
n
I
n
v
e
s
t
m
e
n
t
(
b
u
s
i
n
e
s
s
s
p
e
n
d
i
n
g
o
n
c
a
p
i
t
a
l
)
w
i
l
l
c
h
a
n
g
e
A
D
(
t
o
t
a
l
s
p
e
n
d
i
n
g
)
.
–
If I increases then AD increases
–
The opposite is also true.
RGDP
AD
1
PL
AD
2
An increase in Investment
increases AD
Determinants of Investment
Demand
1.
I
n
t
e
r
e
s
t
r
a
t
e
s
–
t
h
i
s
i
s
t
h
e
c
o
s
t
o
f
b
o
r
r
o
w
i
n
g
o
r
f
o
r
g
o
i
n
g
s
a
v
i
n
g
s
–
If interest rates are high
it would be more
profitable to save and less profitable to
borrow to spend (
Investment decreases
)
–
If
interest rates are low
it would be more
profitable to borrow to spend and less
profitable to save (
Investment increases
)
Affect of Interest Rates on
Investment Demand
I
d
Quantity of Investment
Real Interest Rate
i
1
Q
1
i
2
Q
2
A
B
Real Interest Rate
Quantity of Investment
I
d1
i
1
I
d2
Q
1
Q
2
Affect of a Decrease in Profit
Expectations
or an Increase in
Productive
Capacity
2.
E
x
p
e
c
t
e
d
f
u
t
u
r
e
l
e
v
e
l
o
f
G
D
P
–
I
f
b
u
s
i
n
e
s
s
e
s
e
x
p
e
c
t
G
D
P
t
o
d
e
c
r
e
a
s
e
i
n
t
h
e
f
u
t
u
r
e
t
h
e
y
w
i
l
l
s
p
e
n
d
l
e
s
s
t
o
d
a
y
3.
S
t
o
c
k
o
f
p
r
o
d
u
c
t
i
v
e
c
a
p
i
t
a
l
o
n
h
a
n
d
–
I
f
b
u
s
i
n
e
s
s
e
s
h
a
v
e
p
r
o
d
u
c
t
i
v
e
c
a
p
i
t
a
l
s
i
t
t
i
n
g
i
d
l
e
t
h
e
y
w
i
l
l
d
e
c
r
e
a
s
e
t
h
e
i
r
s
p
e
n
d
i
n
g
t
o
d
a
y
A
c
h
a
n
g
e
i
n
i
n
v
e
s
t
m
e
n
t
c
a
u
s
e
s
t
h
e
A
D
c
u
r
v
e
t
o
s
h
i
f
t
r
i
g
h
t
o
r
l
e
f
t
D
e
t
e
r
m
i
n
a
n
t
s
o
f
I
n
v
e
s
t
m
e
n
t
D
e
m
a
n
d
Cost of Production
•
Any change in the cost of inputs will
change businesses’ profit expectations
and their investment demand.
•
Cost
of inputs
increases
therefore
investment demand decreases
(shifts left).
•
Cost
of inputs
decreases
therefore
investment demand increases
(shifts
right).
•
The major costs of inputs are
wages and
oil.
Business Taxes
•
Increases in businesses taxes reduces
businesses’ profits
and therefore their
investment demand.
•
Business taxes include corporate income
tax, capital gains tax, excise tax.
•
Increases in taxes shift the investment
demand curve left; decreases shift the
curve right.
Technological Change
•
An increase in
technology allows
businesses to produce at a lower cost
and
therefore
increases their profits
and
their
investment
demand.
•
An increase in technology shifts the
investment demand right; a decrease
shifts the curve left.
Expectations of Future Profit
•
An expected future increase in demand for
their product will lead to larger profits and
therefore leads to an immediate increase
in investment demand.
•
An increase in expected future profit shifts
the investment curve to the right; a
decrease shifts the curve to the left.
Stock of Capital on Hand
•
If companies have capital equipment
(factories, tools, etc.) on hand that are not
being utilized there is no reason to
purchase more (investment demand
decreases).
•
If companies are maximizing their use of
capital equipment then they will purchase
more (investment demand shifts right).
Volatility of Investment
•
Investment demand is much more
unstable than Consumption. It changes
often and to a large degree, due to the
following:
–
The durability of capital goods.
–
Innovation occurs irregularly.
–
Profits vary considerably.
–
Business expectations are easily changed.
Adding Government
•
Government policies can have a powerful influence on
aggregate demand
•
G
o
v
e
r
n
m
e
n
t
i
n
f
l
u
e
n
c
e
s
A
D
t
h
r
o
u
g
h
f
i
s
c
a
l
a
n
d
m
o
n
e
t
a
r
y
p
o
l
i
c
y
•
F
i
s
c
a
l
P
o
l
i
c
y
h
a
s
t
w
o
m
a
i
n
c
o
m
p
o
n
e
n
t
s
–
G
o
v
e
r
n
m
e
n
t
s
p
e
n
d
i
n
g
–
g
o
v
e
r
n
m
e
n
t
p
u
r
c
h
a
s
e
s
o
f
g
o
o
d
s
a
n
d
s
e
r
v
i
c
e
s
a
n
d
g
o
v
e
r
n
m
e
n
t
t
r
a
n
s
f
e
r
p
a
y
m
e
n
t
s
•
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
–
T
a
x
&
t
r
a
n
s
f
e
r
p
a
y
m
e
n
t
p
o
l
i
c
i
e
s
•
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.
Taxes
•
Taxes are leakages
•
They reduce AD, but any change in taxes results in a
change in
savings and spending
•
AD decreases by less than the change in taxes due to
our MPC and MPS
PL
RGDP
$450b
AD
1
AD
2
An increase in taxes of
$600 reduces
Consumption and AD by
$450 (MPC = .75)
Adding Government
•
M
o
n
e
t
a
r
y
P
o
l
i
c
y
i
n
v
o
l
v
e
s
t
h
e
u
s
e
o
f
c
h
a
n
g
e
s
i
n
t
h
e
m
o
n
e
y
s
u
p
p
l
y
a
n
d
c
o
n
s
e
q
u
e
n
t
l
y
c
h
a
n
g
e
s
i
n
t
h
e
i
n
t
e
r
e
s
t
r
a
t
e
t
o
a
f
f
e
c
t
o
v
e
r
a
l
l
s
p
e
n
d
i
n
g
l
e
v
e
l
s
–
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.
RGDP
AD
1
PL
AD
2
An increase in
Government spending or
an increase in the money
supply increases AD
N
e
t
E
x
p
o
r
t
s
N
e
t
E
x
p
o
r
t
s
(
e
x
p
o
r
t
s
–
i
m
p
o
r
t
s
)
D
e
t
e
r
m
i
n
a
n
t
s
o
f
N
e
t
E
x
p
o
r
t
s
:
•
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
Economic well-being in the aggregate economy is determined by Real GDP, influenced by current levels of Aggregate Demand (AD) and Aggregate Supply (AS). Aggregate Demand slopes downward due to various effects like Wealth Effect and Interest Rate Effect. It is crucial in determining total spending in an economy through Consumption, Investment, Government, and Net Exports. Changes in Consumption directly impact Aggregate Demand, leading to shifts in the AD curve and Real GDP.
Download Presentation
Please find below an Image/Link to download the presentation.
The content on the website is provided AS IS for your information and personal use only. It may not be sold, licensed, or shared on other websites without obtaining consent from the author. Download presentation by click this link. If you encounter any issues during the download, it is possible that the publisher has removed the file from their server.
E N D
Presentation Transcript
The Aggregate Economy Price Level LRAS AS PL1 Q1 FE RGDP
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.
Down Sloping Nature of AD Price Level A r1 B r2 AD Q2 Q1 RGDP
Aggregate Demand slopes downward for reasons different than the demand curve for a single product Aggregate Demand Wealth Effect Interest Rate Effect Product Demand Income Effect Substitution Effect Aggregate Demand differs from the demand curve for an individual item in that 1. an increase in overall price level does NOT diminish purchasing power because overall income is tied to overall price levels in the macroeconomy 2. when price levels increase there are no cheaper substitutes (all prices are rising)
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)
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
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
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
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
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
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.
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
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
