Aggregate Demand Module 17

Aggregate Demand Just as we can determine a demand curve for a particular good or service, we can also determine an Aggregate Demand Curve that represents demand in the macro economy In this case, it is the demand for a certain level of output (GDP) at a particular price level

Why does it slope downward? Not the same as Law of Demand, where quantity demanded for a good changes with price of a good, all other prices being held constant Ceteris Paribus

Why does it slope downward? Wealth Effect Higher prices reduces purchasing power Consumer spending falls when prices rise Interest Rate Effect Price level affects interest rates As prices rise, people need to save more money Increased interest rates = lower Investment spending

Figure 17.1 The Aggregate Demand Curve Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers

Shift in Aggregate Demand Changes in Expectations Greater optimism leads to more spending at any given price level Changes in Wealth As household assets increase in value, people feel free to spend more at any given price level

Figure 17.2 Shifts of the Aggregate Demand Curve Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition Copyright © 2011 by Worth Publishers

Shift in Aggregate Demand Size of existing stock of physical capital If stock of existing physical capital is large, business will not have to spend as much to meet increasing sales Aggregate demand falls

Government Policy Fiscal Policy Monetary Policy Government spending and tax policy In response to a recession, governments often increase spending and/or decrease taxes Spending = direct Taxes = indirect Monetary Policy The size of the money supply can reduce or increase cost of borrowing Federal Reserve System

What Happens to Aggregate Demand? Business owners are less optimistic about the health of the economy. The government decreases welfare and veteran’s benefits. The Federal Reserve increases interest rates. A rising price level decreases the value of money held for purchases. The government lowers personal income taxes. Consumers expect the job market to be much stronger in the next few months The stock market has reached new records high levels of value. The stock of physical capital has been falling for nearly a year.