1. Warm-up: Turn to your neighbor and explain the following: (Guess if necessary!!!)
Cost-push inflation (Person with the longest hair does the talking)
Demand-pull inflation (Person with the shortest hair does the talking)

2. Aggregate Demand
IB Economics

3. Aggregate Demand Macro concept – WHOLE economy
The sum total of all goods and services demanded in the economy (all final markets)
AD is related to the price level—the average of all prices
Formula:
AD = C+I+G+(X-M)
C= Consumption Spending
I = Investment Spending
G = Government Spending
(X-M) = difference between spending on imports and receipts from exports (Balance of Payments)

4. Aggregate Demand Curve
Shows the amounts of real output that buyers collectively desire to purchase at each possible price level
The relationship between the price level and the amount of real GDP demanded is inverse or negative
When price level rises, the quantity of real GDP demanded decreases and vice versa

5. Aggregate Demand Curve
Price Level AD
Real GDP

6. The Downward Sloping Aggregate Demand Curve-overview
Real-balance effect (a.k.a. Real Wealth Effect)
Interest-Rate effect
Foreign Purchases Effect

7. Aggregate Demand Curve Shape 1. Real-Balances/Wealth Effect
As prices rise the value of bank balances fall.
Because the public is poorer in real terms, they will reduce their spending
Purchase a new car or LCD TV if savings has purchasing power of $50,000
If inflation erodes the purchasing power of its asset balances to say $30,000, then the household may wait to make its purchases
Higher price level = less consumption spending as people act to maintain their real money balances
Conversely, lower price levels = more consumption spending

8. Aggregate Demand Curve Shape 2. Interest-Rate Effect
Assume supply of money to be constant or fixed when drawing the AD Curve
However, when price level increases, consumers need more money for purchases and businesses need more money to meet their payrolls and to buy other resources
Higher price level increases the demand for money
Fixed supply of money an increase in money demanded = increase in the price paid for its use
INTEREST RATE

9. Aggregate Demand Curve Shape 2. Interest-Rate Effect continued . . .
Higher interest rates reduce investment spending and interest-sensitive consumption spending
If 6% rate of return is expected on capital, then:
At 5% interest rate investment is made
At 7% interest rate the investment is not made
Increasing the demand on money & consequently the interest rate, a higher price level reduces the amount of real output demanded

10. Aggregate Demand Curve Shape 3. Foreign Purchases Effect (a. k. a
Aggregate Demand Curve Shape 3. Foreign Purchases Effect (a.k.a. Net Export Effect)
When U.S. price level rises relative to foreign price levels, then:
Foreigners buy fewer U.S. goods (X), &
Americans buy more foreign goods (M)
Rise in the price level reduces the quantity of U.S. goods demanded as net exports
U.S. Exports Fall
U.S. Imports Rise

11. Shifts in the Aggregate Demand Curve
Determinants of AD
“Other things” besides price level
Resulting in Shifts or change in AD
Price Level
AD2 AD
Real GDP

12. Factors causing AD to SHIFT - Overview
Fiscal Policy
Monetary Policy
Foreign Income Changes & Exchange Rates
Future Expectations
External Shocks

13. AD Shift – Fiscal Policy
Definition:
Taxes
Government Spending

14. AD Shift - Monetary Policy
Definition:
Assume increase MS
Investment
Consumer Durables
Savings

15. AD Shift -Foreign Income Changes
Income of foreigners is major determinant of demand
If NI of country A increases then X of country B will increase.

16. AD Shift - Exchange Rates
Value of $ decreasing
Value of $ increasing

17. AD Shift – Future Expectations
Future prices
Business outlook
Future income changes

18. AD shift – Demand side shock (aka external shocks)
National, international, social, and natural events can effect consumers, firms, government and thus AD.

19. Aggregate Demand Exercise
Complete the exercise for Aggregate Demand