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Aggregate Demand

Macro Economics −E202

Things to keep in mind! In order to measure the aggregate quantity of Gs & Ss and the average price level. • Real GNP (GNP valued at constant price) & • GNP Deflator (Average price level measured by GNP deflator) are used respectively. 2 .

governments and foreigners. and of net exports demanded by foreigners. Therefore AD depends on decisions made by households. of investment goods demanded by firms.Definition The aggregate quantity of Gs & Ss demanded is the sum of the quantities f goods and services demanded by households. 3 . of Gs & Ss demanded by govt. firms..

AD Schedule & curve • AD schedule lists the Q of real GNP demanded at each GNP deflator. holding all other influences on buying plans constant. 4 . • AD curve plots the Q of real GNP demanded against the GNP deflator.

The effect of a change in price level and any of other influences • Movement along the AD curve • Shift in AD curve 5 .

6 . Goods and services in the future and 3. Goods and services produced in other countries.Why the AD curve slopes downward? There are three types of substitutes for the Gs & Ss that make up real GNP: 1. Money and Financial assets 2.

7 . • Real money is the measure of money based on the Q of Gs that it will buy. bank deposit 3. • The Q of money includes the Q of: 1. thrift institutions held by HHs and Fs. Currency 2.Money and the Real Balance Effect • Real balance effect is the influence of a change in the Q of real money on the Q of real GNP demanded. deposit at other types of FIs and 4.

the lower the Q of real money. the smaller is the Q of real GNP demanded. the larger is the Q of real GNP demanded.Proposition of Real Balance Effect The higher the Q of real money . the higher the price level (here. the GNP deflator). 8 . Therefore.

Intertemporal Substitution Effect • Substitution of Gs now for Gs later or of Gs later for now. • Interest rate. .increase the AD 9 .increase the Q of real money . is influenced by the Q of real money. Low interest rate encourages people to borrow and spend on K goods and consumer durables.lowers interest rate . which has great influence on it. (e.decrease borrowing .increase lending .) • If P lowers.g.

• Substitution of domestic Gs for foreign Gs or of foreign Gs for domestic Gs. • Lower domestic price encourages people to buy more domestically produced goods instead of goods produced at ROW.International Substitution Effect • 3rd reason why AD curve slopes downward. 10 .

Spending increases Taxes decreases Transfers increases Foreign income increases Population increases 11 .Changes in AD : AD increases if • • • • • • • • • • • Interest rate decreases Expected inflation rate increases Foreign exchange rate falls Expected future profit increases Q of money increases Aggregate wealth increases Govt.