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3.1 Aggregate Demand

4 min readdecember 28, 2022

J

Jeanne Stansak

Haseung Jun

Haseung Jun

J

Jeanne Stansak

Haseung Jun

Haseung Jun

Aggregate Demand

refers to all the goods and services that consumers, firms, and governments are willing and able to purchase at various price levels.

The difference between market demand and is that market demand shows the demand for one good/service at different prices, while shows the demand for all goods and services at different price levels. Instead of quantity, GDP is shown for the x-axis. This is because GDP measures production and not sales. Therefore, it would be accurate to put GDP for the x-axis.

The relationship between the price level and Real GDP output demanded is inverse. As the price level rises, consumers, firms, and government are less willing or less able to purchase the same quantity of Real GDP output and, therefore, end up buying less. As the price level falls, consumers, firms, government, and foreign consumers are more willing or more able to purchase the same quantity of Real GDP output and therefore buy more.

There are three reasons why the curve is downward sloping:

  • Higher prices reduce the purchasing power of money and assets. Lower prices increase the purchasing power of money and assets. As purchasing power changes, the consumption of goods and services will change as well.
  • Prices and interest rates mirror each other. As interest rates rise, firms take out fewer loans and invest less in themselves. As interest rates fall, firms take out more loans and invest in themselves more.
  • As prices rise domestically, exported goods and services become more expensive, and foreign consumers buy less. As prices fall domestically, exported goods and services become cheaper, and foreign consumers by more.

💡When prices increase, the aggregate real GDP output demanded decreases.

https://firebasestorage.googleapis.com/v0/b/fiveable-92889.appspot.com/o/images%2F-HYlTShBd7Ze1.png?alt=media&token=08861749-09d3-4af8-a8c8-601a6ea024ab

The graph above shows . You can see that, as price rises, real GDP decreases, and as price falls, real GDP increases. This law can be illustrated by showing how as price drops from P1 to P2 then real GDP increases from $200 to $300 and as price rises from P3 to P2, real GDP decreases from $400 to $300.

Shifters of Aggregate Demand

Just like demand for an individual good or service, there are factors that can increase (shift to the right) and that can decrease (shift to the left). These factors include all the components of GDP: , , , and . Any changes due to price level have no effect on the AD curve.

https://firebasestorage.googleapis.com/v0/b/fiveable-92889.appspot.com/o/images%2F-SW7bVFMwGGUE.png?alt=media&token=964ce129-454b-4b70-84a3-c8fb61a07b81

Each of the above factors can either increase or decrease . We show those actions on a graph by either shifting the curve to the right or shifting the curve to the left.

https://firebasestorage.googleapis.com/v0/b/fiveable-92889.appspot.com/o/images%2F-VYzCMqH5Zuwz.png?alt=media&token=754fa418-d8e3-4f4c-8952-f2f14aa3886b

For each scenario below determine whether the scenario would increase or decrease and what factor is causing this to happen.

  • South Korea consumer confidence soars.

    • Increase in due to an increase in

  • The British Government votes to shrink the size of its military.

    • A decrease in because there is a decrease in since they are not spending as much money on their military.

  • Due to severe drought, the China's inflation rate climbs by 4%.

    • This is a movement along the curve. The amount of real GDP will decrease because there is an increase in the price level (inflation).

  • As the economy grows and profits increase, Italian firms begin to build more factories.

    • This would be an increase in because it is an increase in by firms in Italy.

  • The US Congress removes a tariff on imported goods, making them less expensive.

    • This would be a decrease in because as imported goods become less expensive than we will see the amount of these goods purchased increase. Since the formula for is exports - imports, when imports increase that number actually decreases which causes a decrease in .

Key Terms to Review (9)

Aggregate demand

: Aggregate demand refers to the total amount of goods and services that all sectors of an economy are willing and able to purchase at a given price level and period of time.

Consumer Spending

: Consumer spending refers to the total amount of money spent by individuals on goods and services in an economy. It is a crucial component of aggregate demand and plays a significant role in driving economic growth.

Foreign Trade Effect

: The foreign trade effect refers to how changes in net exports impact an economy's aggregate demand. An increase in net exports (exports minus imports) leads to an increase in aggregate demand, while a decrease in net exports leads to a decrease in aggregate demand.

Government Spending

: Government spending refers to expenditures made by federal, state, or local governments on goods, services, infrastructure projects, social programs, defense, etc., using taxpayer funds.

Interest Rate Effect

: The interest rate effect refers to how changes in interest rates affect borrowing costs and investment decisions. When interest rates decrease, it becomes cheaper for businesses and individuals to borrow money, leading to increased investment and spending.

Investment Spending

: Investment spending refers to expenditures made by businesses and individuals on capital goods such as machinery, equipment, and buildings. It is one of the components of aggregate demand and contributes to economic growth.

Net Exports

: Net exports represent the difference between a country's total exports (goods and services sold abroad) and its total imports (goods and services purchased from abroad). It indicates whether a nation has a trade surplus (exports exceed imports) or a trade deficit (imports exceed exports).

Real Wealth Effect

: The real wealth effect refers to the change in consumer spending that occurs as a result of changes in the value of assets, such as stocks or housing. When the value of these assets increases, people feel wealthier and tend to spend more.

Shifters of Aggregate Demand

: Shifters of aggregate demand are factors that can cause changes in the overall level of demand for goods and services in an economy. These factors can shift the aggregate demand curve either to the right or left.

3.1 Aggregate Demand

4 min readdecember 28, 2022

J

Jeanne Stansak

Haseung Jun

Haseung Jun

J

Jeanne Stansak

Haseung Jun

Haseung Jun

Aggregate Demand

refers to all the goods and services that consumers, firms, and governments are willing and able to purchase at various price levels.

The difference between market demand and is that market demand shows the demand for one good/service at different prices, while shows the demand for all goods and services at different price levels. Instead of quantity, GDP is shown for the x-axis. This is because GDP measures production and not sales. Therefore, it would be accurate to put GDP for the x-axis.

The relationship between the price level and Real GDP output demanded is inverse. As the price level rises, consumers, firms, and government are less willing or less able to purchase the same quantity of Real GDP output and, therefore, end up buying less. As the price level falls, consumers, firms, government, and foreign consumers are more willing or more able to purchase the same quantity of Real GDP output and therefore buy more.

There are three reasons why the curve is downward sloping:

  • Higher prices reduce the purchasing power of money and assets. Lower prices increase the purchasing power of money and assets. As purchasing power changes, the consumption of goods and services will change as well.
  • Prices and interest rates mirror each other. As interest rates rise, firms take out fewer loans and invest less in themselves. As interest rates fall, firms take out more loans and invest in themselves more.
  • As prices rise domestically, exported goods and services become more expensive, and foreign consumers buy less. As prices fall domestically, exported goods and services become cheaper, and foreign consumers by more.

💡When prices increase, the aggregate real GDP output demanded decreases.

https://firebasestorage.googleapis.com/v0/b/fiveable-92889.appspot.com/o/images%2F-HYlTShBd7Ze1.png?alt=media&token=08861749-09d3-4af8-a8c8-601a6ea024ab

The graph above shows . You can see that, as price rises, real GDP decreases, and as price falls, real GDP increases. This law can be illustrated by showing how as price drops from P1 to P2 then real GDP increases from $200 to $300 and as price rises from P3 to P2, real GDP decreases from $400 to $300.

Shifters of Aggregate Demand

Just like demand for an individual good or service, there are factors that can increase (shift to the right) and that can decrease (shift to the left). These factors include all the components of GDP: , , , and . Any changes due to price level have no effect on the AD curve.

https://firebasestorage.googleapis.com/v0/b/fiveable-92889.appspot.com/o/images%2F-SW7bVFMwGGUE.png?alt=media&token=964ce129-454b-4b70-84a3-c8fb61a07b81

Each of the above factors can either increase or decrease . We show those actions on a graph by either shifting the curve to the right or shifting the curve to the left.

https://firebasestorage.googleapis.com/v0/b/fiveable-92889.appspot.com/o/images%2F-VYzCMqH5Zuwz.png?alt=media&token=754fa418-d8e3-4f4c-8952-f2f14aa3886b

For each scenario below determine whether the scenario would increase or decrease and what factor is causing this to happen.

  • South Korea consumer confidence soars.

    • Increase in due to an increase in

  • The British Government votes to shrink the size of its military.

    • A decrease in because there is a decrease in since they are not spending as much money on their military.

  • Due to severe drought, the China's inflation rate climbs by 4%.

    • This is a movement along the curve. The amount of real GDP will decrease because there is an increase in the price level (inflation).

  • As the economy grows and profits increase, Italian firms begin to build more factories.

    • This would be an increase in because it is an increase in by firms in Italy.

  • The US Congress removes a tariff on imported goods, making them less expensive.

    • This would be a decrease in because as imported goods become less expensive than we will see the amount of these goods purchased increase. Since the formula for is exports - imports, when imports increase that number actually decreases which causes a decrease in .

Key Terms to Review (9)

Aggregate demand

: Aggregate demand refers to the total amount of goods and services that all sectors of an economy are willing and able to purchase at a given price level and period of time.

Consumer Spending

: Consumer spending refers to the total amount of money spent by individuals on goods and services in an economy. It is a crucial component of aggregate demand and plays a significant role in driving economic growth.

Foreign Trade Effect

: The foreign trade effect refers to how changes in net exports impact an economy's aggregate demand. An increase in net exports (exports minus imports) leads to an increase in aggregate demand, while a decrease in net exports leads to a decrease in aggregate demand.

Government Spending

: Government spending refers to expenditures made by federal, state, or local governments on goods, services, infrastructure projects, social programs, defense, etc., using taxpayer funds.

Interest Rate Effect

: The interest rate effect refers to how changes in interest rates affect borrowing costs and investment decisions. When interest rates decrease, it becomes cheaper for businesses and individuals to borrow money, leading to increased investment and spending.

Investment Spending

: Investment spending refers to expenditures made by businesses and individuals on capital goods such as machinery, equipment, and buildings. It is one of the components of aggregate demand and contributes to economic growth.

Net Exports

: Net exports represent the difference between a country's total exports (goods and services sold abroad) and its total imports (goods and services purchased from abroad). It indicates whether a nation has a trade surplus (exports exceed imports) or a trade deficit (imports exceed exports).

Real Wealth Effect

: The real wealth effect refers to the change in consumer spending that occurs as a result of changes in the value of assets, such as stocks or housing. When the value of these assets increases, people feel wealthier and tend to spend more.

Shifters of Aggregate Demand

: Shifters of aggregate demand are factors that can cause changes in the overall level of demand for goods and services in an economy. These factors can shift the aggregate demand curve either to the right or left.


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© 2024 Fiveable Inc. All rights reserved.

AP® and SAT® are trademarks registered by the College Board, which is not affiliated with, and does not endorse this website.