Aggregate Demand
Module 17
Aggregate Demand
• Just as we can determine a demand curve for
a particular good or service, we can also
determine an Aggregate Demand Curve that
represents demand in the macro economy
• In this case, it is the demand for a certain level
of output (GDP) at a particular price level
Why does it slope downward?
Not the same as Law of Demand, where
quantity demanded for a good changes with
price of a good, all other prices being held
constant
Ceteris Paribus
Why does it slope downward?
• Wealth Effect
– Higher prices reduces purchasing power
– Consumer spending falls when prices rise
• Interest Rate Effect
– Price level affects interest rates
– As prices rise, people need to save more money
– Increased interest rates = lower Investment
spending
Figure 17.1 The Aggregate Demand Curve
Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition
Copyright © 2011 by Worth Publishers
Shift in Aggregate Demand
• Changes in Expectations
– Greater optimism leads to more spending at any
given price level
• Changes in Wealth
– As household assets increase in value, people feel
free to spend more at any given price level
Figure 17.2 Shifts of the Aggregate Demand Curve
Ray and Anderson: Krugman’s Macroeconomics for AP, First Edition
Copyright © 2011 by Worth Publishers
Shift in Aggregate Demand
• Size of existing stock of physical capital
– If stock of existing physical capital is large,
business will not have to spend as much to meet
increasing sales
– Aggregate demand falls
Government Policy
• Fiscal Policy
– Government spending and tax policy
– In response to a recession, governments often
increase spending and/or decrease taxes
• Spending = direct
• Taxes = indirect
• Monetary Policy
– The size of the money supply can reduce or increase
cost of borrowing
– Federal Reserve System
What Happens to Aggregate Demand?
1. Business owners are less optimistic about the health of the
economy.
2. The government decreases welfare and veteran’s benefits.
3. The Federal Reserve increases interest rates.
4. A rising price level decreases the value of money held for
purchases.
5. The government lowers personal income taxes.
6. Consumers expect the job market to be much stronger in the next
few months
7. The stock market has reached new records high levels of value.
8. The stock of physical capital has been falling for nearly a year.