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AGGREGATE DEMAND (DOC)

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					AGGREGATE DEMAND

AD = Y= C + I + G + X – M

  Total expenditures are composed of
   consumption, investment, government
   spending, and exports less imports.
  These expenditures make up the aggregate
   demand for all the goods and services in
   the economy.
  Anything that increases or decreases these
   will increase or decrease the total demand
   for goods and services.
AGGREGATE DEMAND AND THE
PRICE LEVEL.

We need to see the relationship between the
PRICE LEVEL and aggregate demand.

If the price level rises, the quantity of goods
and services demanded will fall other things
being equal.

If the price level falls, the quantity of goods
and services demanded will rise, other things
being equal.
WHY DOES AD SLOPE DOWN?

  The reasons are not the same as the
   reasons why a micro demand curve slopes
   down.
     o      All output prices are changing in
       the domestic economy. There is no
       substitution effect on the AD curve. In
       micro demand, the relative price of one
       good changes, so there is a substitution
       effect.
     o      The quantity demanded at a given
       REAL GDP is changing. Real income
       remains the same. In micro demand, a
       rise in price does reduces income. If
       the price of a good such as housing,
       tuition, gasoline or home heating fuel
       rises, the impact may be substantial
AGGREGATE DEMAND SHIFTS FIRST
BECAUSE OF THE:

Wealth effect:
  Accumulated wealth is worth less when
  prices rise.

  As prices rise, the value of money in the
   bank falls. Bonds and any other money
   assets fixed in price also fall in value. The
   funds saved up to buy a car, a stereo, to
   pay tuition and room and board will no
   longer be adequate to make the purchase.
  People saving for their retirement will see
   that the amount saved is less adequate for
   their future needs. They need to save
   more, decreasing current spending.
  The Interest Rate Effect

  As prices rise, more money is needed to buy
  and sell the same quantity of goods. Banks
  will find they have less money sitting in
  people’s accounts that they can lend out.
  Since banks lend less, interest rates rise, and
  investment spending and consumer durable
  purchases fall.
(There is a lot going on in that statement; we
will have to discuss it carefully.)
International substitution effect:

Domestically produced goods are less
competitive with foreign produced goods
when prices rise.

  A rise in the price level, other things
   remaining the same, increases the price of
   domestic goods relative to foreign
   goods, so imports increase and exports
   decrease, which decreases the quantity of
   real GDP demanded.
  Similarly, a fall in the price level, other
   things remaining the same, decreases the
   price of domestic goods relative to
   foreign goods, so imports decrease and
   exports increase, which increases the
   quantity of real GDP demanded.
SHIFTS IN AGGREGATE DEMAND

AD = Y= C + I + G + X – M

Anything other than a change in output prices
or in Real GDP that increases AD shifts the
AD curve to the right.

Anything other than a change in output prices
or in Real GDP that decreases AD shifts the
AD curve to the left.
SUMMARY: Influences on Aggregate
Demand

AD INCREASES         AD DECREASES
1. Expectations
Prices, incomes or   Prices, incomes or
profits are expected profits are expected
to rise              to fall
2. Government policy
Increasing G         Decreasing G
Decreasing net taxes Increasing net taxes
Increasing the Money Decreasing the
supply               Money supply
3. The World Economy
The exchange rate    The exchange rate
falls                rises
Foreign income rises Foreign income falls
CAUSES OF SHIFTS IN AGGREGATE
DEMAND
  1. Expectations about:
       a.   Prices:
If prices are expected to rise, people and
firms will buy more now to avoid higher
prices later. Current AD increases and shifts
right.
If prices are expected to fall, people and firms
will buy less now to benefit from lower prices
later. Current AD decreases and shifts left.
       b. Incomes
If incomes are expected to rise, people will be
more willing to borrow money to buy a car or
a house. Current AD increases and shifts
right.
If incomes are expected to fall, people will be
less willing to borrow money to buy a car or a
house. Current AD decreases and shifts left.
CAUSES OF SHIFTS IN AGGREGATE
DEMAND
  2. Government policy:
      a. Fiscal policy
Fiscal policy are government decisions about
tax rates, transfer payments (net taxes) and
government spending on goods and services
(G)
If government spending on goods and services
(G) increases AD increases and shifts right.

If government spending on goods and services
(G) decreases AD decreases and shifts left.
 3. Government policy:
     a. Fiscal policy

    Decreasing net taxes (cutting taxes or
raising transfer payments like the GST rebate)
increases households’ DISPOSABLE
INCOME (Income with taxes deducted and
transfers added in). Increasing disposable
income increases consumption (C) and AD
increases and shifts right.
Increasing net taxes (increasing taxes or
lowering transfer payments) decreases
households’ DISPOSABLE INCOME
Decreasing disposable income decreases
consumption (C) and AD decreases and
shifts left.
CAUSES OF SHIFTS IN AGGREGATE
DEMAND
  4. Government policy:
      b. Monetary policy
Monetary policy is the change in interest rates
and the quantity of money in the economy.
The Bank of Canada influences the interest
rate by altering the quantity of money in the
economy.
    How that is done is the subject of a later
chapter in the text.
    The Bank of Canada could just issue each
of us a cheque for $1000. (Usually it buys
bonds.) Money in the economy increases.
    The Bank of Canada can also cause
money in the economy to decreases.
(Usually it sells bonds.)
If money in the economy increases then AD
increases and shifts right.

a. We would spend some. Consumption (C)
increases and AD increases and shifts right.

b. We would save some. Rising savings in the
bank drive down interest rates. Lower interest
rates encourage borrowing so consumption
(C) increases and investment (I) increases.
AD increases and shifts right.
If money in the economy decreases then AD
decreases and shifts left.

a. We would spend less. Consumption (C)
decreases and AD decreases and shifts right.

b. We would save less. Falling savings in the
bank drive up interest rates. Lower interest
rates encourage borrowing so consumption
(C) decreases and investment (I) decreases.
AD decreases and shifts left.
THE WORLD ECONOMY INFLUENCES
CANADIAN AGGREGATE DEMAND

 1. The exchange rate

 The exchange rate is the price of the
 Canadian dollar. Usually we express it in
 the dollars US it costs to buy a dollar
 Canadian. Right now the rate is about $.82.

  a. If the price of the Canadian dollar falls,
  say from $.82 to $.75, then it takes fewer
  US dollars to buy a Canadian dollar. It also
  takes more Canadian dollars to buy a US
  dollar
Canadian goods become cheaper to
Americans and US goods become more
expensive to Canadians. Exports rise and
imports fall. (X-M) increases. AD increases
and shifts right.
 2. The exchange rate

 b. If the price of the Canadian dollar rises,
 say from $.75 to $.85, then it takes more US
 dollars to buy a Canadian dollar. It also
 takes fewer Canadian dollars to buy a US
 dollar.

Canadian goods become more expensive to
Americans and US goods become cheaper to
Canadians. Exports fall and Imports rise. (X-
M) decreases. AD decreases and shifts left.

In the 1990s, the falling value of the Canadian
dollar tended to increase net Exports and
increased AD. Right now, the rising value of
the Canada is tending to reduce net Exports
and decrease AD.
THE WORLD ECONOMY INFLUENCES
CANADIAN AGGREGATE DEMAND

 2. Foreign Incomes

If foreign incomes rise, the demand for
Canadian exports (X) increases. AD
increases and shifts right.

If foreign incomes fall, the demand for
Canadian exports (X) decreases. AD
decreases and shifts left.

 An American recession slows down the
 Canadian economy by decreasing AD. An
 American expansion speeds up the Canadian
 economy by increasing AD.
SOME INFLUENCES ON
AGGREGATE DEMAND
 Changes in the world economy and in the
  value of the Canadian dollar and in the
  Canadian price level will alter X – M
  exports and imports.
 Changes in Government spending
  decisions will alter G, government
  spending of goods and services.
 Changes in interest rates or in expectations
  about future profits will alter I,
  investment.
 Changes in taxes, transfer payments,
  interest rates, and expectations will alter
  disposable income. Lower disposable
  income reduces C, consumption
  spending.

				
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