2 Aggregate demand and supply Aggregate demand – a relationship between the price level and the equilibrium quantity of real GDP demanded.Aggregate supply – a relationship between the price level and the equilibrium quantity of real GDP supplied.
9 Aggregate demand Aggregate demand (AD) consists of spending on GDP by: consumers (C)firms (I)the government (G), andthe foreign sector (X)Anything that increases C, I, G, or X at a given price level results in an increase in AD.
10 Factors affecting Consumption IncomeWealthExpected future income and wealthDemographicsTaxes
11 Factors affecting Investment Interest rateTechnologyCost of capital goodsCapacity utilization
12 Government spendingDetermined by government authorities
13 Factors affecting net exports Foreign and domestic incomeForeign and domestic price levelsExchange ratesGovernment policy (tariffs, trade restrictions, etc.)
14 Aggregate expenditures AE = C+I+G+XAE is affected by any factor that changes C, I, G, or X.
15 Aggregate demandNote that AD curve is not the same as the demand curve for a particular goodnegative slope is NOT the result of income and substitution effectsWhy is it downward sloping?Wealth effectInterest rateInternational trade effect
16 Wealth effect As the price level rises: the real value of dollar-denominated assets decline (real wealth declines)this decline in wealth results in a reduction in consumption spendingThis effect is also called the real-balance effect (or Pigou effect)
17 Interest-rate effect As the price level rises: Individuals must hold more money to pay for transactionsTo acquire more money, households sell bonds, and other financial assets.As more bonds are sold, the price of bonds declinesA decline in bond prices results in a higher rate of return (interest rate) on bonds and other financial assetsA higher interest rate results in a reduction in investment and consumption spending
18 International trade effect As the domestic price level rises:Imports become relatively cheaper,Exports become relatively more expensiveExports decline, imports rise, and net exports decline
19 Combined price-level effects As the price level rises, AE falls due to the combined wealth, interest-rate, and international trade effects
20 Nonprice determinants of AD Anything that changes C, I, G, or X at a given price level will cause the AD curve to shiftEffects of:Expectations (consumer and investor confidence)Foreign income and price levelsGovernment policy
21 Aggregate supply Price-level effects Assumption: Resource prices adjust more slowly than output pricesAs price level rises, production becomes more profitable and the quantity of output supplied rises.