Aggregate DemandAggregate Demand

Supply and Demand NationallySupply and Demand Nationally In microeconomics, In microeconomics,

supply and demand supply and demand show just one industry show just one industry (e.g., sodas, iPods, cell (e.g., sodas, iPods, cell phones)phones)

Macroeconomics is Macroeconomics is interested in interested in entireentire economyeconomy

We can use the We can use the philosophies of supply philosophies of supply and demand and demand in in aggregateaggregate to understand to understand the whole economythe whole economy

Analyzing AD and AS Analyzing AD and AS helps us analyze helps us analyze inflation, GDP, inflation, GDP, employment, and employment, and government policiesgovernment policies

Aggregate DemandAggregate Demand Sum of all demands Sum of all demands

for all the goods and for all the goods and services in all final services in all final marketsmarkets

Final markets are the Final markets are the “end” of the value “end” of the value chain: for the end chain: for the end consumerconsumer

AD is the sum of AD is the sum of spending of spending of consumers, consumers, investment, investment, government, and net government, and net exportsexports

AD = C + I + G + X - MAD = C + I + G + X - M

Graphing Aggregate DemandGraphing Aggregate Demand

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Real GDP (1990 Dollars)

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AD Slopes DownwardAD Slopes Downward

Slope is same as Slope is same as for regular for regular demand, but demand, but reasons are reasons are different (but different (but related)related)

AD slopes AD slopes downward becausedownward because– Real Wealth EffectReal Wealth Effect– Net Exports EffectNet Exports Effect– Interest Rate EffectInterest Rate Effect

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Real GDP (1990 Dollars)

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Real Wealth EffectReal Wealth Effect As prices rise, the As prices rise, the

real value of people’s real value of people’s savings falls savings falls

Example: $20 saved Example: $20 saved in 1970 will have lost in 1970 will have lost value by 2010 due to value by 2010 due to inflationinflation

As prices rise, people As prices rise, people save more to save more to maintain their saved maintain their saved valuevalue

If people save more, If people save more, they spend less, so they spend less, so GDP fallsGDP falls

Net Export EffectNet Export Effect As prices rise in one’s As prices rise in one’s

country, country, importsimports seem seem cheapercheaper

Example: as prices for Example: as prices for California wines rise, California wines rise, Americans buy Chilean Americans buy Chilean wineswines

As prices in general rise As prices in general rise in one country, in one country, exportsexports seem more expensive to seem more expensive to other countriesother countries

Example: as prices in Example: as prices in America rise, Europeans America rise, Europeans buy German software buy German software instead of American instead of American softwaresoftware

As As net exportsnet exports fall, GDP fall, GDP fallsfalls

Interest Rate EffectInterest Rate Effect As prices rise, interest rates As prices rise, interest rates

tend to rise too (banks need tend to rise too (banks need to profit above inflation, so to profit above inflation, so they raise interest rates on they raise interest rates on new loans)new loans)

With higher interest rates, With higher interest rates, consumers are less likely to consumers are less likely to borrow, and so are less borrow, and so are less likely to make large likely to make large purchases, like houses and purchases, like houses and carscars

Higher rates encourage Higher rates encourage savings, not spendingsavings, not spending

Higher rates discourage Higher rates discourage investment (companies are investment (companies are discouraged from borrowing discouraged from borrowing to invest)to invest)

Higher rates discourage Higher rates discourage gov’t spending (currently gov’t spending (currently governments borrow to governments borrow to spend, too)spend, too)

Shifting ADShifting AD

Any change to C, G, I, or XAny change to C, G, I, or XNN

Common causesCommon causes– Change in interest rates affect C, G, I, XChange in interest rates affect C, G, I, XNN

– Change in government spending (G)Change in government spending (G)– Change in income taxes (change consumers’ Change in income taxes (change consumers’

disposable income, so changes spending)disposable income, so changes spending)– Change in consumer confidence (e.g., Change in consumer confidence (e.g.,

terrorism, or fear of layoffs)terrorism, or fear of layoffs)– Stock market change, housing market change, Stock market change, housing market change,

affect consumer confidence and spendingaffect consumer confidence and spending– Change in populationChange in population