Aggregate Demand Curve

8 Key excerpts on "Aggregate Demand Curve"

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  eBook - ePub

  Economic Principles and Problems

  A Pluralist Introduction

  • Geoffrey Schneider(Author)
  • 2021(Publication Date)
  • Routledge

    (Publisher)

  e . The economy always ends up at the equilibrium price level and real GDP where AD = AS.

  Next, we turn to more details regarding the aggregate demand and aggregate supply curves.

  Aggregate demand (AD) is the total quantity of output (of goods and services) demanded by all sectors in the economy at various price levels. Aggregate demand is made up of five components: consumption (C), investment (I), government spending (G), exports (X), and imports (IM).

  A D = C + I + G + X − I M .

  Consumption refers to consumer purchases of goods and services. Investment refers to businesses’ purchases of investment goods and services, such as machinery, equipment, and construction services that expand the physical size of businesses’ operations. Government spending includes all government purchases of goods and services, such as the services of soldiers and teachers, the construction of roads, and so on. Exports refers to foreign purchases of domestically produced goods and services, such as U.S. exports to Europe. Imports refers to domestic purchases of foreign-produced goods and services, such as U.S. imports from Europe. Note that imports are subtracted from aggregate demand because increased spending on imports means that less money is spent in the domestic economy.

  Slope of aggregate demand. The Aggregate Demand Curve slopes downward because of three effects:

  1. The real balance effect: Higher prices mean less real wealth for consumers, causing consumers to spend less. Similarly, lower prices increase consumers’ purchasing power, leading to increases in consumer spending.
  2. The real interest rate effect: Higher prices cause real interest rates to rise because firms and individuals need to borrow more money to pay for more expensive goods. This results in decreases in spending on goods purchased with borrowed funds, including consumers’ purchases of houses and cars and businesses’ purchases of investment goods.
  3. The foreign trade effect: Higher prices on U.S. goods and services makes U.S. goods less competitive, reducing exports (X) while making imports more attractive to U.S. citizens and thereby increasing imports (IM). The reduction in X and increase in IM decreases aggregate quantity demanded.

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  eBook - ePub

  A Primer on Macroeconomics, Second Edition, Volume II

  Policies and Perspectives

  • Thomas M. Beveridge(Author)
  • 2018(Publication Date)
  • Business Expert Press

    (Publisher)

  Figure 5.1 .

  We discussed real GDP (y) in Chapter 3 (Volume I), and the aggregate price level (P) in Chapter 4 (Volume I), but let us review. Real GDP is our measure of aggregate output, measured in constant dollars. The aggregate price level is our measure of the overall average price of goods and services, as measured by the Consumer Price Index or the GDP price deflator.

  Composition of Aggregate Demand: From Chapter 3 and the Expenditure Approach to calculating GDP, recall that the demand for goods and services is composed of expenditures by households (consumption, C), businesses (investment, I), government (government purchases, G), and foreigners (net exports, EX – IM). Aggregate demand, then, is composed of these elements:

  AD = C + I + G + (EX – IM)

  What the AD curve isn’t . Although the AD curve looks very similar to the demand curves we have seen in previous chapters, it is different in significant ways—it’s not just a “big” demand curve.

  Note that, on the vertical axis, “price” is the aggregate price level (P). In the “demand for oranges” diagram, the price of one good (oranges) is on the price axis—here, the aggregate price level is the price of all

  goods and services in the macroeconomy. The distinction is important. In Chapter 2, when we considered the behavior of quantity demanded in a single market such as the market for oranges, we assumed that, if the price of oranges were to rise, then all other factors would be held constant—the

  ceteris paribus assumption. A change in the price of oranges would occur in isolation, without changes in income, wealth, prices of other goods, and so on.

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  eBook - ePub

  Essentials of Economics in Context

  • Neva Goodwin, Jonathan M. Harris, Pratistha Joshi Rajkarnikar, Brian Roach, Tim B. Thornton(Authors)
  • 2020(Publication Date)
  • Routledge

    (Publisher)

  11 , we explained economic theories concerning fiscal and monetary policy. So far, most of our macroeconomic analysis has focused on the “demand side,” examining how changes in consumption, investment, and government spending might affect the levels of aggregate demand in the economy. In this chapter, we complete this story, with explicit attention to the problem of inflation. Then we move on to “supply-side” issues that determine the productive capacity of the economy and influence the level of output. Finally, we will arrive at a model that puts demand and supply issues together.

  1. AGGREGATE DEMAND AND INFLATION

  Recall from Chapter 9 that aggregate demand is the total quantity of goods and services demanded by households, businesses, government, and the international sector in the economy. It is represented by the total spending, which is the sum of consumption, investment, government spending, and net exports. Since the level of spending is influenced by the changes in price levels, we use the aggregate demand (AD) curve to represent the relationship between the equilibrium level of output and inflation.

  aggregate demand (AD) curve

  : graph showing the relationship between the rate of inflation and the total quantity of goods and services demanded by households, businesses, government, and the international sector

  1.1 The Aggregate Demand Curve

  The Aggregate Demand Curve is graphically represented with output (denoted by Y) on the horizontal axis and the rate of inflation on the vertical axis (denoted by the symbol p).1 The AD curve is shown in Figure 12.1 . It is downward sloping,

  Figure 12.1

  The Aggregate Demand Curve

  indicating that higher inflation rates will tend to reduce total demand. This reasoning is based on the following effects of inflation on total demand:

  • When inflation rises, it reduces the value of money assets. Even if this does not reach the level of hyperinflation, it hurts savers and people who have money balances. This real wealth effect tends to reduce their consumption, lowering total demand.
  • Inflation also lowers the real money supply, defined as M/P, where M is the nominal money supply and P is the general price level. This has an effect similar to contractionary monetary policy, raising interest rates, discouraging investment, and lowering aggregate demand.
  • Inflation hurts net exports by making domestically produced goods more expensive for foreigners and imports more attractive for domestic consumers. This decreases aggregate demand by decreasing net exports.2

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  eBook - ePub

  Macroeconomics For Dummies

  • Dan Richards, Manzur Rashid, Peter Antonioni(Authors)
  • 2016(Publication Date)
  • For Dummies

    (Publisher)

  The AD-AS model is built on simple, sensible intuition. Used carefully, it can be helpful for both explaining and predicting macroeconomic events.

  This chapter explores one half of the AD–AS model: aggregate demand (AD). As its name suggests, you can think of AD as representing the combined demand for goods and services of all economic agents — in other words, the combined demand of domestic consumers, firms, and government, plus any net foreign demand. (To read about aggregate supply (AS), flip to Chapter 11 .)

  We describe the various parts that make up aggregate demand and examine the AD curve. Along the way you see why AD increases when the price level falls and how the exchange rate affects a country’s net exports. There’s some algebra involved, but don’t worry. We lead you through it and explain everything clearly step-by-step.

  Looking into What Everyone Wants: Aggregate Demand

  Economies run on people, firms, and governments requiring and buying things. A need exists (demand) that firms fulfill (supply). Students of microeconomics spend time learning about the behavior of supply and demand in individual markets (see Microeconomics For Dummies, U.S. Edition by Lynne Pepall (Wiley, 2015). Students of macroeconomics are interested in the economy as a whole, so the emphasis is on aggregate (that is, total) demand for goods and services and aggregate (total) supply.

  More specifically, aggregate demand comprises the total demand for goods and services produced in the economy.

  Aggregate demand is important because (along with aggregate supply) it determines a country’s GDP and price level (and therefore its inflation rate). Changes in aggregate demand also impact the level of unemployment.

  Without understanding aggregate demand, policy-makers wouldn’t stand much of a chance of being able to control the economy. Indeed the main tools that policy-makers have at their disposal (monetary and fiscal policy) work by influencing aggregate demand.

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  The American Economy: A Student Study Guide

  A Student Study Guide

  • Wade L. Thomas, Robert B. Carson(Authors)
  • 2015(Publication Date)
  • Routledge

    (Publisher)

  The cyclical behavior of the economy has long attracted economists’ attention and a variety of explanations have been put forward to explain the expansion and contraction of the economy. Indeed, the business cycle remains at the center of macroeconomic theory and policy-making objectives. 4. The principal tool of the modern-day macroeconomist in efforts to study and explain aggregate economic behavior is aggregate demand and aggregate supply analysis. By viewing aggregate output of the economy in terms of spending for goods and services (aggregate demand) and the output values of actual production (aggregate supply), the relationships that exist between price levels and levels of real output can be discerned. Shifts in aggregate demand and aggregate supply necessarily affect price level-output combinations

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  Foundations of Macroeconomics

  Its Theory and Policy

  • Frederick S. Brooman(Author)
  • 2017(Publication Date)
  • Routledge

    (Publisher)

  CHAPTER 3Aggregate Demand, Output, and Equilibrium      

  1. Aggregate Demand and Supply

  In Chapter 1 , the equilibrium of the economy was roughly described in terms of aggregate demand and supply. It was said that when the amount of money everyone wishes to spend is equal to the value of the goods and services currently being made available for purchase, the economy is in equilibrium in the sense that the situation will not itself cause changes in the general level of prices, in the level of output, or in anything else. But the concept of equilibrium implies the possibility of disequilibrium: aggregate demand may be equal to aggregate supply, but it may also be larger or smaller at any particular time. In this, there is a marked contrast with the relationship between National Expenditure and National Product, since these are identical in amount at all times and under all circumstances; they can never be said to be in equilibrium, because they can never differ. Nonetheless, the concepts defined in the previous chapter can be used to throw light on the conditions of equilibrium between aggregate demand and supply.

  For the time being, the notion of aggregate supply will be likened to that of National Product. This does not mean that the two are to be regarded as identical; National Product is simply a numerical measure of the flow of output, whereas the concept of supply involves the idea of volition – it is the quantity that sellers wish to sell, rather than the amount that they merely happen to have available from current production. Firms will be content to produce a given level of output only if they believe that they could not improve their profits by either increasing or reducing it It will be shown in a later chapter 1

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  eBook - ePub

  Chinese Economists on Economic Reform – Collected Works of Lou Jiwei

  • Lou Jiwei, China Development Research Foundation(Authors)
  • 2013(Publication Date)
  • Routledge

    (Publisher)

  Equilibrium in aggregate supply and demand, and equilibrium in ‘the use of national income’ and the ‘production of national income,’ are two pairs of economic concepts that are used to analyze short-term economic phenomena. Using them as analytical tools can help us touch upon certain structural issues in our national economy and its prospects for long-term steady growth. They cannot be used to explain these issues in a fully comprehensive way. Nonetheless, equilibrium in our aggregate economy is the basis for any structural evolution and long-term steady growth. One could even say that correcting short-term imbalances in the overall economy is a prerequisite for steady economic growth. Therefore, it is absolutely necessary to have a deep understanding of the full meaning of these two pairs of concepts, as well as how they differ in terms of the policy considerations each one implies.

  Articles on economic topics in our country often equate the ‘aggregate demand and aggregate supply equilibrium’ with ‘equilibrium in use of our national income and the production of our national income.’ They refer to an ‘excess of aggregate demand over aggregate supply’ as though it were the same as the ‘excess distribution of the national income.’ In fact, these two pairs of concepts are linked but also have certain distinctions. The implications of their corresponding parts are not equivalent. Let’s look at a comparative analysis.

  1. The aggregate supply and the amount of ‘national income production’

  Simply put, ‘aggregate supply’ refers to those products and services that have an ‘actual practical-use value’ that can be produced by existing production capacities within one year. It can be roughly expressed in terms of the expected gross national product (GNP) as measured in constant prices, or by the expected national income. The thing that aggregate supply focuses on is the production capacity of such productive factors as assets, labor, land, imported materials, and foreign capital inflows. Within any given year, these are limited. Each is constrained by the quantity and quality of all other factors. For example, a quantitative maximum is imposed on imported materials and the amount of our foreign debt by the smallest extent of foreign exchange reserves and the highest amount of debt-servicing. ‘Aggregate supply’ refers to the maximum amount of ‘well-being’ that can be produced by the full capacity of production factors, after they are combined in optimal fashion. It is also referred to as the ‘production-possibility frontier’ or the ‘potential production level.’ We should say that referring to the maximum well-being of people is more accurate, since it excludes from the figures production of overstocked things that people don’t need, either for immediate or long-term consumption (as investment).

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  eBook - ePub

  How Real is the Federal Deficit?

  • Robert Eisner(Author)
  • 2010(Publication Date)
  • Free Press

    (Publisher)

  G = government expenditures for goods and services X ⋚ 0 → ΔY ⋚ 0 X = excess demand

  (1)	(2)	(3)	(4)	(5)	(6)	(7)	(8)
  Y	C	ID	G	NE	AD	X	EQUILIBRIUM
  A. Debt =$#2,000 billion
  4,100	2,624	695	860	-112	4,067	-33	↓
  4,000	2,560	680	860	-100	4,000	0	=
  3,900	2,496	665	860	-88	3,933	+33	↑
  B. Debt = $2,330 billion
  4,100	2,657	695	860	-112	4,100	0	=
  4,000	2,593	680	860	-100	4,033	+33	↑
  3,900	2,529	665	860	-88	3,966	+66	↑

  In example A, with a debt of $2,000 billion, total wealth, including real wealth of the private sector, will be $15,000 billion and the equilibrium output will be $4,000 billion. For at any greater output, aggregate demand would be less than output, and at any lesser output, aggregate demand would be greater than output. Thus, at an output of $4,100 billion, aggregate demand, the sum of consumption plus investment demand plus government purchases of goods and services plus net exports, would be only $4,067 billion, leaving a shortage of demand of $33 billion. When business consequently reduces production it finds consumption declining, as people’s incomes, out of which they consume, decline, and investment demand declines as well. Only when output and income are down to $4,000 billion, is aggregate demand no longer less than output. Similarly, if output and income were below their equilibrium level, say $3,900 billion, there would be excess demand driving output up to the $4,000 billion equilibrium.

  What can change that equilibrium is a change in any of the components of aggregate demand—a change in the table’s columns for consumption, investment demand, government expenditures, or net exports. As we commonly explain in our economics principles classes, equilibrium output would be raised if business were persuaded to buy more new plant and equipment, thus raising the investment demand column, if government itself bought more goods and services, thus raising the “G—column, or if foreigners could be persuaded to buy more of our goods and services, thus raising the net export column. (In this last case, since net exports have been shown negative, reflecting our current unfavorable balance of trade, initially it would mean making the figures less negative.)

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