Aggregate Demand
- demand by consumers, businesses, government, and foreign countries
- relationship between price
level and real GDP output is indirect
Reasons Why AD is Downward Sloping
- Real - Balance Effect- higher price levels reduce the purchasing power of money
- decreases the quantity of
expenditures
- Lower price levels increase
purchasing power and increase expenditures.
2. Interest - Rate Effect- When the price level increases,
lenders need to charge higher interest rates to get a return on their
loans.
- Higher interest rates discourage business investment and consumption
3. Foreign Trade Effect- When U.S price level rises, foreign
buyers purchase fewer U.S goods and Americans buy more foreign goods.
- Exports fall and imports rise
causing real GDP demanded to fall
Shifts of AD
- components of GDP (Consumption, Domestic Investment, Government Spending, and Net Exports) shift AD
Consumption
1. Consumer wealth
- More wealth = more spending
(AD shifts right)
- Less wealth = less spending
(AD shifts left)
2. Consumer
expectations
- Positive expectations = more
spending (AD shifts right)
- Negative Expectations = less
spending (AD shifts left)
3.Household Indebtedness
- Less debt = more spending
(AD shifts right)
- More debt = less spending (AD shifts left)
Domestic Investment
1. Real interest
rate
- Lower real interest rate = more
investment (AD shift right)
- Higher real interest rate = less
investment (AD shifts left)
2. Expected
Returns
- Higher expected returns = more
investment (AD shift right)
- Lower expected returns = less
investment (AD shift left)
- Expected returns are influenced by:
Expectations of future profitability, Technology, Degree of excess
capacity, Business taxes
Government Spending
- More government spending (AD shift
right)
- Less government spending (AD
shift left)
Net Exports
1. Exchange Rates
- Strong USD = more imports and fewer
exports (AD shifts to left)
- Weak USD = fewer imports and more
exports (AD shifts to right)
2. Relative Income
- Strong foreign economy = more
exports (AD shifts to right)
- Weak foreign economy = less exports (AD shifts to left)
Aggregate Supply
- level of real GDP that firms will produce at each price level
Long run AS
- Period of time where input prices
are completely flexible and adjust to changes in the Price level
- In the long-run, the level of Real GDP supplied is independent of the price level
- Long-run Aggregate Supply or LRAS marks the level of full employment output
- LRAS is vertical at the economy's level of full employment.
Short run AS
- Period of time where input prices
are sticky and do not adjust to changes in the price level.
- In the short run, the level of real
GDP is directly related to the price level
- Because input prices are sticky in the short-run, SRAS is upward sloping
Shifts in SRAS
- An increase in SRAS is a shift to
the right.
- A decrease in SRAS is a shift to
the left
- Per unit cost of production = Total
input cost / Total output
Input Prices
- Domestic Resource Prices
- Wages (75% of all business costs)
- Cost of Capital
- Raw materials (commodity prices)
- Foreign Resource Prices
- Strong USD = lower foreign resource prices
- Weak USD = higher foreign resource prices
- Market Power
- Monopolies and cartels that control resources control
the price of those resources
-Increase in Resource Prices = SRAS
left
-Decrease in Resource Prices = SRAS
right
Productivity -
Total output / Total inputs
- More productivity- lower unit
production cost = SRAS right
- Lower productivity-higher unit
production cost = SRAS left
Legal-Institutional
Environment
- Taxes (money to government) on business increase per unit production cost = SRAS left
- Subsidies (money from government) to business reduce per unit production cost = SRAS right
Government
Regulation
- Government regulation creates a cost of compliance = SRAS left
- Deregulation reduces compliance costs = SRAS right
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