Aggregate demand shows the relationship between the

This preview shows page 61 - 64 out of 80 pages.

Aggregate Demand Shows the relationship between the aggregate price level and the total quantity of aggregate output demanded by households, businesses, and the government at each price level GDP = C + I + G + NX Downward sloping - 1. Wealth effect - lower prices increase the real value of money (nominal value is fixed) and this allows you to buy more goods and services and essentially demand a higher quantity of goods and services (not covered in class) 2. Interest rate effect - price level and investment - when the price level drops, people demand less money (households need less to buy goods and services) and therefore they might use excess money to buy interest-bearing bonds or invest in savings accounts - these actions drive down interest rates. Lower interest rates means borrowing is less expensive so firms invest in new plants and equipments and households buy large durable purchases such as cars! Decrease in price level decreases the transaction demand for money Therefore the demand for money demand curve shifts left When the money demand curve shifts left, this decreases the interest rate for a given money supply This leads to an increase in investment expenditure Because I is a component of aggregate demand, there will be an increase in the Q of goods and services demanded
3. Real exchange rate effect - price levels and net exports - RER = (e x P) / P* Decrease in the Canadian price level (holding the foreign exchange rate constant) makes Canadian goods cheaper than foreign goods (as P goes down, RER depreciates, people want more Canadian goods)
This increases exports of Canadian goods and decreases imports of foreign goods Quantity of Canadian goods and services therefore rises at a lower Canadian price level Example RER - the number of units of foreign goods that can be purchased with one unit of domestic goods RER = 4 euros/dollar x 200 dollars / 1600 Euros RER = 0.5 Say, price decreases to 150 dollars! Now RER is 0.375 You can buy FEWER units of foreign goods for one unit of domestic good As a result, your demand for domestic goods increases Why the Demand Curve Might Shift to Left (all have to do with Y = C + I + G + NX) 1. Change in consumption Business or consumer confidence - if businesses and consumers become pessimistic (from something like a fall in stock prices) about the economic future, they will purchase fewer capital goods, new houses and consumer durables (at the existing price level) - this will also shift the curve the left 2. Change in investment - under government purchases for some reason ... Transfer payments (fiscal policy) Monetary policy (change in money supply --> increased interest rates) 3. Change in government purchases Fiscal policy - to stabilize the economy, involves the use of: Government spending - government purchases of final goods and services, and government transfers o Government purchases directly shift the curve because of direct affect on G - If G decreases, the AD curve shifts left!

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture