Skip to main content

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.
Labels:
Location: New York, NY, USA

Comments

Post a Comment

Popular posts from this blog

Macroeconomics: multiplier and crowding out effects

Multiplier effect: whenever   any of the components of AD increases, the increase in GDP will be greater than the initial increase in expenditures. The impact on GDP of a particular increase in spending depends on the proportion of the new income that is taken out of the system to the proportion that continues to circulate in the economy. The multiplier effect tells us the impact a particular change in one the components of AD will have on the total income (GDP).  Let k denote the spending multiplier, which is a function of MPC and MPS. The larger the marginal propensity to consume, the larger the spending multiplier. Notice that the larger the MPC, the greater the impact a particular change in the spending variables will have on the nation's GDP. The crowding out effect: If government spending increases without an increase in taxes, the government must borrow funds from the private sector to finance its deficit, thereby increasing the interest rate. This increase in interest ...
Post a Comment
Read more

Microeconomics: Firms and cost in the short run

In Economics, the term short run refers to a time period where at least one variable of interest does not change . In our case, the short run for a firm is when at least one input  (labor, land, capital) stays fixed. Usually land and capital are considered fixed in the short run.  If an input is fixed during a period time, no matter how much the total product a firm produces, its cost stays the same. This cost is commonly known as fixed cost (FC). Examples of fixed costs: rent, property taxes, loan payments. Labor is often considered to be a part of the  variable cost (VC) . Variable cost can be defined as the cost a firm has control over during the short run. Unlike fixed cost, variable cost increases (decreases) as a firm's total product increases (decreases). Examples of variable costs include: utility bills, wages, raw materials A firm's total cost (TC) is the sum of its variable and fixed costs. As you can see, the fixed cost...
Post a Comment
Read more

Exercise: inflation and GDP deflator

You have the following table containing information about country Y's GDP deflator, nominal, and real GDP. If the base year is 2015, fill in the blanks and then find the annual inflation rate for each year. Year  Nominal GDP  GDP Deflator  Real GDP 2015 $23,457 100 $23,457 2016 $25,752 ... $23,943 2017 $25,982 108.1 ... 2018 $26,016 ... $25,431.1 2019 $26,323 105.5 ... Solution: Year  Nominal GDP  GDP Deflator  Real GDP   Inflation rate 2015 $23,457 100 $23,457 n.a 2016 $25,752 107.6 $23,943 7.6% 2017 $25,982 108.1 $24,035.2 0.45% 2018 $26,016 102.3 $25,431.1 -5.37% 2019 $26,323 105.5 $24,950.6 3.13%  GDP deflator for the year 2018: Real GDP for the year 2017: General formula to find real GDP by re-arranging the GDP deflator formula: Notice that the sub-index i is for the year. The (annual) inflation rate is simply the growth rate of prices from a year to its previous year: Inflation rate of the year 2018: Notice that in 2018 country Y experienced...
Post a Comment
Read more