Aggregate Demand: Total quantity of aggregate output of an economy, Real GDP, that

consumers want to buy at various price levels.

Aggregate Demand = Consumption Spending + Investment Spending + Government Spending

+ Net Exports

1. Wealth Effect: When the price level goes up and there is inflation the value of people’s
assets decrease and so less stuff is bought and when the price level goes down there is
more purchasing power to buy more stuff.
2. Interest Rate Effect: The idea that if the price level goes up there are going to be higher
levels of interest rates and with higher interest rates consumption and investment will
decrease. The interest rate goes up when price goes up because people need more
money to buy things so they borrow more or liquidize more of their assets.
 Negative Slope of AD Curve

The Aggregate Demand curve has a negative relationship between Price Levels and
Real GDP.

An increase in Price Levels leads to a decrease in Real GDP.

Three Reasons:

1. Wealth Effect:​ If the Price Level (PL) increases the Real value of wealth
decreases. People feel poorer & spend less.
2. Interest Rate Effect (IR):​ Increase in PL people & businesses need more
money for purchases - Increase in Demand for money - increase IR - increase in
cost to borrow money.
3. International Trade Effect:​ If domestic PL increase it becomes more expensive
for other countries to buy from you so the other countries decrease spending.
 Micro Demand vs. Macro AD

Microeconomics Demand

● Reflects the willingness of the consumer to buy one specific product at different
price levels.
● Downward sloping because of the diminishing MArginal Benefit derived from
consuming the product.

Macroeconomics Aggregate Demand

● Reflects the willingness of all possible buyers including consumers, businesses,

government, and foreigners.
● Downward sloping AD is due to the Wealth Effect, Interest Rate Effect, and
Trade Effect. Diminishing Marginal Benefit is not a factor.

Movement along the AD curve

Movement along the AD curve (changes in Price Level)is caused by:

1. The Wealth Effect

2. Interest Rate Effect
3. Trade Effect

Shifts in AD
Shifts in Aggregate Demand are caused by changes in:

1. Consumption Spending
2. Business Spending
3. Government Spending
4. (Exports - Imports) - Net Exports
 Consumption Spending

Increases (right shifts) and Decreases (left shift) in Aggregate Demand

Changes in Consumer Spending caused by:

1. Changes in consumer confidence

2. Changes in Interest Rates
3. Changes in Wealth
4. Changes in personal income taxes
5. Changes in the level of household debt

Investment Spending

Increases (right shifts) and Decreases (left shift) in Aggregate Demand are caused by:

Changes in Investment Spending caused by:

1. Changes in Business confidence

2. Changes in Interest Rates (monetary policy)
3. Changes or improvements in technology
4. Changes in Business taxes
5. Change in the amount of corporate debt
6. Legal changes
 Government Spending

Increases (right shifts) and Decreases (left shift) in Aggregate Demand are caused by:

Changes in Government Spending caused by:

1. Changes in Political Priorities

2. Changes in Economic Priorities - efforts to change Aggregate Demand through
increase/decrease in spending.

Net Exports - (Exports - Imports)

Increases (right shifts) and Decreases (left shift) in Aggregate Demand are caused by:

Changes in Net Exports caused by:

1. Changes in National Income abroad

2. Changes in exchange rates
3. Changes in levels of trade protection - tariffs, quotas, trading blocs