Aggregate Demand

Aggregate Demand November-24-08 8:21 AM

Aggregate Demand - the relationship between the general price level and total spending in the economy. - made up of spending by C, I, G, and (X-M). Real Expenditure - total spending in an economy, adjusted for changes on the general price level, is calculated by using the GDP deflator Aggregate Demand Curve

Price Level

Real GDP

Demand Curve - relationship between the general price level and total spending in the economy expressed on a graph Demand Schedule - shows relationships between general price level and total spending in the economy expressed in a table Price Low = Demand High Amount Spend by an Entire Economy is Determined by: 1. Wealth Effect: - when price level rises, the real value of households financial assets decreases. Because consumers feel they have less wealth, they spend less on consumption items. As a result of this wealth effect, real expenditures drop Real Value of Financial Assets = Nominal value financial assets / price level 2. Foreign Trade Effect - with changes in the price level, expenditures on imports change in the same direction, while expenditures on exports change in the opposite direction. a. When the price level in Canada rises, Canadian exports become more expensive for foreigners sales in foreign markets fall - decreasing in export expenditures. b. Products imported into Canada become cheaper relative to higher- priced domestic products import expenditures by Canadian rise. c. Foreign Trade Effect - Net exports (X-M)

Changes In Aggregate Demand

1. Consumption a. Disposable income b. Wealth (wealth effect)

Unit 3 - Fiscal Policy Page 1

b. Wealth (wealth effect) c. Consumer expectations d. Interest rates 2. Investment (limited to planned investment) a. Real rate of return - constant dollar extra profit provided by a project each year, slated as a percentage of the projects initial cost. b. Investment Demand - the relationship between interest rates and investments c. Investment Demand Schedule - relationship between interest rates and investments expressed in a table d. Investment Demand Curve - the relationship between interest rates and investments expressed on a graph Investment Influenced by: 1) Interest rates 2) Business expectations 3. 4. 5. 6.

Government Purchases Net Exports Foreign Incomes (FDI) Exchange Rates

Shifts in Aggregate Demand Curve

Aggregate demand increases and the AD curve shifts to the right, with the following: 1. An increases in consumption due to: a. A rise in disposable income b. A rise in wealth unrelated to a change in rice level c. A expected rise in prices or incomes d. A fall in interest rates 2. An increase in investment due to: a. A fall in interest rates b. An expected rise in profits 3. An increase in government Purchases 4. An increase in net exports due to: a. A rise in foreign incomes b. A fall in value of the Canadian dollar

Aggregate demand decreases and the AD curve shifts to the left with the following: 1. An decrease in consumption due to: a. A fall in disposable income b. A fall in wealth unrelated to a change in rice level c. A expected fall in prices or incomes d. A rise in interest rates 2. An decrease in investment due to: a. A rise in interest rates b. An expected fall in profits 3. An decrease in government Purchases 4. An decrease in net exports due to: a. A fall in foreign incomes b. A rise in value of the Canadian dollar

10.1 Practise Questions a) b) c) d)

Shift to right, rise in disposable income (CONSUMPTION) Shift to left Shift to left, net exports Shift to right, investment, consumption Unit 3 - Fiscal Policy Page 2

d) Shift to right, investment, consumption e) Shift to left, net exports f) Shift to left, investment

Unit 3 - Fiscal Policy Page 3