• Aggregate Demand
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Macroeconomics - Aggregate demand–aggregate supply
The AD-AS model has become the
standard textbook model for
explaining the macroeconomy. This
model shows the price level and level
of real output given the equilibrium in
aggregate demand and aggregate
supply. The aggregate demand curve's
downward slope means that more
output is demanded at lower price
levels.
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Aggregate demand
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The aggregate demand curve is in fact
downward sloping as a result of three
distinct effects: Pigou effect|Pigou's
wealth effect, Keynes effect|the
Keynes' interest rate effect and the
Mundell–Fleming model|MundellFleming exchange-rate effect
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Aggregate demand
The aggregate demand curve
illustrates the relationship between
two factors - the quantity of output that
is demanded and the aggregated price
level
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Aggregate demand
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If the money supply was increased and
thus aggregate demand increased,
there would be a movement up along
the Long run aggregate supply curve.
The cost of this is a permanently higher
level of prices. As a result of increase
in aggregate demand, the economy will
gravitate toward the natural level more
quickly.
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Aggregate demand - History
First, he argued that with a lower
‘effective aggregate demand’, or the
total amount of spending in the
economy (lowered in the Crash), the
private sector could subsist on a
permanently reduced level of activity
and involuntary unemployment,
unless there was active intervention
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Aggregate demand - Components
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An aggregate demand curve is the sum of
individual demand curves for different
sectors of the economy. The aggregate
demand is usually described as a linear
sum of four separable demand sources:
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Aggregate demand - Components
(Inventory accumulation would
correspond to an excess supply of
products; in the National Income and
Product Accounts, it is treated as a
purchase by its producer.) Thus, only
the planned or intended or desired
part of investment ('Ip') is counted as
part of aggregate demand
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Aggregate demand - Components
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This shifts the aggregate
demand curve to the left
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Aggregate demand - Components
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In sum, for a single country at a given
time, aggregate demand ('D' or 'AD') =
'C' + 'Ip' + 'G' + '(X-M)'.
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Aggregate demand - Aggregate demand curves
Understanding of the aggregate
demand curve depends on whether it is
examined based on changes in demand
as income changes, or as price change.
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Aggregate demand - Aggregate demand-aggregate supply model
Sometimes, especially in textbooks,
aggregate demand refers to an entire
demand curve that looks like that in a
typical Marshallian demand|Marshallian
supply and demand diagram.
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Aggregate demand - Aggregate demand-aggregate supply model
Carefully using ideas from the theory of
supply and demand, aggregate supply can
help determine the extent to which increases
in aggregate demand lead to increases in
real output (economics)|output or instead to
increases in prices (inflation). In the diagram,
an increase in any of the components of 'AD'
(at any given 'P') shifts the 'AD' curve to the
right. This increases both the level of real
production ('Y') and the average price level
('P').
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Aggregate demand - Debt
A Post-Keynesian theory of aggregate demand
emphasizes the role of debt, which it considers a
fundamental component of aggregate
demand;[http://www.debtdeflation.com/blogs/2009/12/
01/debtwatch-no-41-december-2009-4-years-ofcalling-the-gfc/ Debtwatch No 41, December 2009: 4
Years of Calling the GFC], Steve Keen, December 1,
2009 the contribution of change in debt to aggregate
demand is referred to by some as the
.[http://ssrn.com/paper=1595980 Credit and Economic
Recovery: Demystifying Phoenix Miracles], Michael
Biggs, Thomas Mayer, Andreas Pick, March 15, 2010
Aggregate demand is spending, be it on consumption,
investment, or other categories
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Aggregate demand - Debt
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Since write-offs and savings rates both
spike in recessions, both of which
result in shrinkage of credit, the
resulting drop in aggregate demand
can worsen and perpetuate the
recession in a vicious cycle.
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Aggregate demand - Debt
Indeed, a fall in the level of debt is not
necessary – even a slowing in the rate of
debt growth causes a drop in aggregate
demand (relative to the higher borrowing
year).However much you borrow and
spend this year, if it is less than last year, it
means your spending will go into
recession
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Aggregate demand - Criticisms
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Austrian School|Austrian theorist Henry
Hazlitt argued that aggregate demand is a
meaningless concept in economic
analysis. Friedrich Hayek, another
Austrian, argued that Keynes' study of the
aggregate relations in an economy is
fallacious, as recessions are caused by
micro-economic factors.
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Effective aggregate demand
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The aggregate demand curve is plotted
with real gross domestic product|real
output on the horizontal axis and the price
level on the vertical axis
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Effective aggregate demand
Aggregate demand is expressed
contingent upon a fixed level of the real
versus nominal value
(economics)|nominal money supply
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Effective aggregate demand
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According to the AD–AS model|aggregate
demand-aggregate supply model, when
aggregate demand increases, there is
movement up along the aggregate supply
curve, giving a higher level of
prices.Mankiw, N. Gregory, and William M.
Scarth. Macroeconomics. Canadian ed.,
4th ed. New York: Worth Publishers, 2011.
Print.
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Pigou effect - Integration with Keynesian Aggregate Demand
Keynes argued that a drop in aggregate
demand could lower employment and,
simultaneously, the price level; an
occurrence observed in the deflationary
Great depression|depression). In the IS-LM
framework of Keynesian economics, as
formalized by John Hicks, a negative
aggregate demand shock would shift the LM
curve left due to rising real wages changing
liquidity preference. The Pigou effect would
counterbalance this by shifting the IS curve
right due to rising real balances raising
expenditures.
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AD-AS model - Aggregate demand curve
The Aggregate demand curve AD, which is
downward sloping, is derived from the IS/LM model.
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AD-AS model - Aggregate demand curve
The real money supply has a positive
effect on aggregate demand, as does real
government spending (meaning that when
the independent variable changes in one
direction, aggregate demand changes in
the same direction); the exogenous
component of taxes has a negative effect
on it.
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AD-AS model - Shifts of aggregate demand and aggregate supply
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The following summarizes the exogenous
events that could shift the aggregate
supply or aggregate demand curve to the
right. Exogenous events happening in the
opposite direction would shift the relevant
curve in the opposite direction.
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AD-AS model - Shifts of aggregate demand
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The following exogenous events would
shift the aggregate demand curve to
the right. As a result, the price level
would go up. In addition if the time
frame of analysis is the short run, so
the aggregate supply curve is upward
sloping rather than vertical, real
output would go up; but in the long run
with aggregate supply vertical at full
employment, real output would
remain unchanged.
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AD-AS model - Shifts of aggregate demand
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Rightward aggregate
demand shifts
emanating from the IS
curve:
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