Unit 3: Aggregate Demand Curve 2/16/17

• AD is the demand by consumers, business, government, and foreign countries.

Changes in price level cause a move along the curve not a shift of the curve.

Aggregate Demand (AD):

• The relationship between the price level & the level of the real GDP.

Three reasons why AD is downward sloping:

1. Wealth Effect:

- Higher prices reduce purchasing power of $

- This decreases the quantity of expenditures

- Lower price levels increase purchasing power & increase expenditures

2. Interest Rate Effect:

- As price level increases, lenders need to charge higher interest rates to get a REAL return on their loans

- Higher interest rates discourage consumer spending and business investment

3.Foreign Trade Effect:

- When US price level rises, foreign buyers purchase fewer, US goods & Americans buy more foreign goods.

- Exports fall & imports rise causing real GDP demanded to fall (Xn Decreases)

Shifts in AD

There are two parts to a shift in AD:

- Change in C, Ig, G and/or Xn

- Multiplier effect that produces a greater change than the original change in the 4 components

• Increases in AD = AD shifts right
• Decreases in AD = AD shifts left