Step 14: What's Aggregate mean? (Start of Unit 3)

Aggregate Demand

• shows amount of real GDP that the private, public, and foreign sector collectively desire to purchase at each possible price level
• relationship between price level and level of real GDP is inverse, which means as price level goes up, real GDP goes down.

Three reasons why Aggregate Demand AD is downward sloping

1. Real-Balance Effect

• when price level (PL) is high, households and businesses cannot afford to purchase as much output
• when PL is low, households and businesses can afford to purchase as much output

    2.  Interest-Rate Effect 

• higher PL increases interest rate, which tends to discourage investment
• lower PL decreases interest rate, which tends to encourage investment

    3. Foreign Purchases Effect

• higher PL increases demand for relatively cheaper inputs
• lower PL increase foreign demand for relatively cheaper U.S. exports

Shifts in AD

• Two parts to shift in AD
  -change in C, Ig, G, and/or Xn
  -multiplier effect that produces greater change than the original change in the four components
• increase in AD shifts the graph to the right
• decrease in AD shifts the graph to the left

Consumption

• Household spending is affected by:
  
  -Consumer wealth
  More wealth means more spending, which shifts AD to the right
  Less wealth means less spending, which shifts AD to the left
  
  -Consumer expectations
  Positive expectations means more spending, which shifts AD to the right
  Negative expectations means less spending, which shifts AD to the left
  
  -Household indebtedness
  Less debt means more spending, which shifts AD to the right
  More debt means  less spending, which shifts AD to the left
  
  -Taxes
  Less taxes mean more spending, which shifts AD to the right
  More taxes mean less spending, which shifts AD to the left

Gross Private Investment

• Investment Spending is sensitive to:
  
  -Real Interest Rate
  Lower real IR means more investment, which shifts AD to the right
  Higher real IR means less investment, which shifts AD to the left
  
  -Expected Returns
  Higher expected returns mean more investment, which shifts AD to the right
  Lower expected returns means less investment, which shifts AD to the left
  Expected returns are influenced by:
  ~expectations in future profitability
  ~changes in technology
  ~degree of excess capital (Existing Stock of Capital)

Government Spending

• More government spending shifts AD to the right
• Less government spending shifts AD to the left

Net Exports

• Net Exports are sensitive to:
  Exchange Rates (internet value of money)
  -Strong money = more imports and lower exports, which shifts AD to the left
  -Weak money = fewer imports and more exports, which shifts AD to the right
  Relative Income
  -Strong foreign economy = more exports = AD shifts right
  -Weak foreign economy = less exports = AD shifts left