1. Unit 3: National Income and Price Determination1
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2. Topic 3.1- Aggregate Demand (AD)
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3. What is Aggregate Demand?
Aggregate- “added all together.”
When we use aggregates we combine all prices and all quantities.
Aggregate Demand is all the goods and services (real GDP) that buyers are willing and able to purchase at different price levels.
The Demand for everything by everyone in the US.
There is an inverse relationship between price level and Real GDP.
If the price level:
Increases (inflation), then real GDP demanded falls.
Decreases (deflation), the real GDP demanded increases. 6
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4. Aggregate Demand Curve
AD is the demand by consumers, businesses, government, and foreign countries.
Price
Level
What definitely doesn’t shift the curve?
Changes in price level cause a move along the curve. AD
= C + I + G + Xn
Real domestic output (GDPR) 7
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5. Why is AD downward sloping?
The Wealth Effect-
Higher price levels reduce the purchasing power of money. This decreases the quantity of expenditures.
Lower price levels increase purchasing power and increase expenditures.
AKA Real Balance Effect
Example:
If the price level doubles, people are going to buy less stuff because they have less purchasing power.
So…price level goes up, GDP demanded goes down. 8
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6. Why is AD downward sloping?
2. Interest Rate Effect-
When the price level increases, lenders need to charge higher interest rates to get a REAL return on their loans.
Higher interest rates discourage consumer spending and business investment.
Example: An increase in prices leads to an increase in the interest rate from 5% to 25%. You are less likely to take out loans to improve your business.
So…price level goes up, GDP demanded goes down. 9
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7. Why is AD downward sloping?
3. Foreign Trade Effect-
When U.S. price level rises, foreign buyers purchase fewer U.S. goods and Americans buy more foreign goods.
Exports fall and imports rise causing real GDP demanded to fall. (XN Decreases)
Example: If prices triple in the US, Canada will buy fewer US goods causing quantity demanded of US products to fall.
So…price level goes up, GDP demanded goes down. 10
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8. Shifters of Aggregate Demand
GDP = C + I + G + Xn 11
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9. Shifts in Aggregate Demand
An increase in spending shifts AD right, and decrease in spending shifts it left.
Price
Level
AD1 AD
= C + I + G + Xn
AD2
Real domestic output (GDPR) 12
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10. Shifters of Aggregate Demand
Change in Consumer Spending
Increase in Disposable Income (Higher incomes…)
Consumer Expectations (People fear a recession…)
Household Indebtedness (More consumer debt…)
Taxes (Decrease in income taxes…)
2. Change in Investment Spending
Real Interest Rates (Price of borrowing $)
(If interest rates increase…)
(If interest rates decrease…)
Future Business Expectations (High expectations…)
Productivity and Technology (New robots…)
Business Taxes (Higher corporate taxes means…) 13
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11. Shifters of Aggregate Demand
Change in Government Spending
Government Expenditures
(Decrease in defense spending…)
(Increase in public works programs…)
Change in Net Exports (X-M)
Exchange Rates
(If the us dollar depreciates relative to the euro…)
National Income Compared to Abroad
(If a major importer has a recession…)
(If the US has a recession…)
AD = GDP = C + I + G + Xn 14
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12. Aggregate Demand Practice
State if there will be an increase or decrease in AD.
State which component of AD caused the change.
The stock market is on the rise this year.
The government decreases its spending.
People except the economy to improve.
The U.S. increases its exports to China.
Ford builds several new factories in the U.S.
Interest rates are on the rise.
The U.S. Dollar appreciates, making U.S.
goods more expensive for foreign consumers.
The government raises taxes.
There is an 8% increase in price level.
Increase, C
Decrease, G
Increase, Xn
Increase, I
Decrease, I
Decrease, Xn
Decrease, C
NO SHIFT
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13. 2012 Audit Exam
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