Macro.docx - Chap 13 Aggregate demand(AD curve A curve that...

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Chap 13 Aggregate demand (AD) curve A curve that shows the relationship between the price level and the quantity of real GDP demanded by households, firms, and the government. The fact that it is downward sloping reflects an inverse relationship between the price level and the quantity of real GDP demanded. The inverse relationship is the result of three effects: 1. Wealth effect. A household's wealth is the difference between its assets and its debts. Some assets are generally held in cash (nominal assets) which lose value as the price level increases. Households demand a smaller quantity of goods and services as prices rise, and a larger amount of goods and services as prices fall. 2. Interest rate effect. When the price level increases, firms and households need more money to conduct their daily business. As a result, they withdrawal money from banks, borrow money, or sell assets. This drives up interest rates. When interest rates increase, borrowing is more expensive. Therefore, firms and households borrow less money to use for investment capital and new homes. The reverse is true when the price level falls. 3. International-trade effect. When the U.S. price level increases relative to other countries, U.S. goods (exports) are now relatively more expensive and foreign goods (imports) are less expensive. Aggregate demand (AD) curve A curve that shows the relationship between the price level and the quantity of real GDP demanded by households, firms, and the government. The fact that it is downward sloping reflects an inverse relationship between the price level and the quantity of real GDP demanded. The inverse relationship is the result of three effects: 1. Wealth effect. A household's wealth is the difference between its assets and its debts. Some assets are generally held in cash (nominal assets) which lose value as the price level increases. Households demand a smaller quantity of goods and services as prices rise, and a larger amount of goods and services as prices fall. 2. Interest rate effect. When the price level increases, firms and households need more money to conduct their daily business. As a result, they withdrawal money from banks, borrow money, or sell assets. This drives up interest rates. When interest rates increase, borrowing is more expensive. Therefore, firms and households borrow less money to use for investment capital and new homes. The reverse is true when the price level falls. 3. International-trade effect. When the U.S. price level increases relative to other countries, U.S. goods (exports) are now relatively more expensive and foreign goods (imports) are less expensive. Next Question Long-run aggregate supply (LRAS) curve A curve that shows the relationship in the long run between the price level and the quantity of real GDP supplied. In the long run, however, the level of GDP is affected only by the number of workers, the capital stock, and available technology. That is, the only thing that shifts the LRAS curve is economic growth.

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