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Macroeconomics: aggregate demand

Aggregate demand:

  • Aggregate demand: a function relating price level and the amount of output of a nation demands in a given time period.
    • This function aggregates the demands of all consumers for all the goods and services produced in a nation in a given time period at different price levels.
    • There is an inverse relationship between the quantity of real output demanded and the price level. The lower (higher )the price levels, the greater (lower) the amount of output demanded.
    • Aggregate demand measures the demand for a nation's output of goods and services in a year.  It closely resembles the expenditure approach of calculating the GDP.
  • Aggregate demand for a country depends on four types of spending:
    • Consumption (C): all spending by domestic households on goods and services.
    • Investment (I): all spending by firms on capital goods and by households on real estate.
    • Government spending (G): measures a country's government's expenditures on goods and services.
    • Net export(Xn or X-M): total income earned from sales of export minus total income spent on imports.
  • Aggregate demand curve:

  • Three explanations for the inverse relationship between the average price level (PL) and the real national output (rGDP):
    • Wealth Effect: higher prices reduces the purchasing power of domestic households' wealth and savings. The public feels poorer at higher prices and therefore demands a lower quantity of the nation's output.
    • Interest Rate Effect: in response to an increase in the price level, banks will the interest rates on loans to households and firms. At higher interest rates, the quantity demanded of goods for which households and firms need to borrow decreases.
    • Net Export Effect: as the price level in a country rises, keeping everything else equal, the goods and services produced in that country become less attractive to foreign consumers, and imports become more attractive to domestic buyers. Therefore, at higher price levels, less of a nation's output is demanded than at lower price levels.
    • A change in the price level of a nation's output will lead to a movement along the AD curve, and a change in the quantity demanded.
  • Shift in the AD curve:
    • A change in any of the non-price level determinants of aggregate demand will cause a shift in the AD curve
    • AD will shift to the right (left) if C,I,G, or Xn increase (decrease).
Reference: Welker, Jason. AP Maroeconomics Crash Course. Research & Education Association (2014). p 107-109.
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