Aggregate Demand
AD=CIGXn
AD =CIGXn Consumption
• Main determinant is income
• Other determinants:
– Wealth (value of assets) if W
C S
– Expectations (for TT% or future wealth)
– Debts (if D increases, C & S will decrease)
– Taxes (if T increase, C & S decrease, etc)
AD =CIGXn Investment
Investment is:
– Business spending for capital stock
– Most volatile component of AD/GDP
– Assumed to require a loan
– Decisions are based on
MC (i%) vs. MB(exp Rate of Ret)
AD =CIGXn
Government Spending
• More Government Spending (AD)
• Less Government Spending (AD)
AD =CIGXn
Net Exports
• Xn are sensitive to: TrIPS
– Taste/real interest rates/Investment/Price level/Speculation
SID = More M and Fewer X = (AD )
WES = Fewer M and More X = (AD )
LUKE, Use the FOREX
Changes (Δ) in AD
• Δ Consumption (C)
– C↑ .: AD  .: GDPR↑ & PL↑ .: u%↓ & π%↑
– C↓ .: AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓
• Δ Gross Private Investment (IG)
– IG↑ .: AD  .: GDPR↑ & PL↑ .: u%↓ & π%↑
– IG↓ .: AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓
• Δ Government Spending (G)
– G↑ .: AD  .: GDPR↑ & PL↑ .: u%↓ & π%↑
– G↓ .: AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓
• Δ Net Exports (XN)
– XN↑ .: AD  .: GDPR↑ & PL↑ .: u%↓ & π%↑
– XN↓ .: AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓
Increase in AD
LRAS
PL
SRAS

P

P1
AD1
AD

Y
YF
GDPR
C↑, IG↑, G↑ and/or XN↑ .: AD  .: GDPR↑ & PL↑ .: u%↓ & π%↑
Decrease in AD
LRAS
PL
SRAS

P

P1
AD
AD1

YF
Y
GDPR
C↓, IG↓, G↓ and/or XN↓ .: AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓
If the G has a balanced budget
• They are spending = to taxes collected
• If they increase spending and don’t have a
balanced budget = borrowing
It will come from the loanable funds
market, therefore raising the r% by
crowding us out.
If AD goes down
• Transfer payments will increase b/c the
increase in u% will lead to more people
applying for welfare and other benefits.
Extra determinates of AD
• ▲’s consumer confidence
if we have optimism then AD>
• ▲’s in wealth – assets value > then AD >
• ▲’s monetary policy – if the Fed > MS then AD>
AD Summary
• AD reflects an inv rel beetw PL and GDPR
• Δ in PL creates real-balance, i%, and foreign
purchase effects that explain AD’s downward
slope
• Δ in C, IG, G, XN cause Δ in GDPR bc they Δ AD.
• Increase in AD = AD 
• Decrease in AD = AD 
Full Employment
• Full Employment equilibrium exists where AD
intersects SRAS & LRAS at the same point.
PL
LRAS
SRAS
P
AD
YF
GDPR
Recessionary Gap
• A recessionary gap exists when equilibrium occurs
below full employment output.
SRAS
LRAS
PL
P
AD
Y
YF
GDPR
Inflationary Gap
• An inflationary gap exists when equilibrium occurs
beyond full employment output.
PL
LRAS
SRAS
P
AD
YF Y
GDPR
Increase in AD = Up/left movement
along SRPC
PL
SRAS
SRPC

π1
π


P1
..
AD1
AD

Y
YF

P
.
.
LRAS
π%
GDPR
un
u
C↑, IG↑, G↑ and/or XN↑
.: AD  .: GDPR↑ & PL↑ .: u%↓ & π%↑ .: up/left along SRPC
u%
Decrease in AD = Down/right along
SRPC
LRAS
PL

P1
.
SRAS
SRPC
π

.

P
π%
.
.
π1
AD
AD1

YF
Y

GDPR
u
un
u%
C↓, IG↓, G↓ and/or XN↓
.: AD  .: GDPR↓ & PL↓ .: u%↑ & π%↓ .: down/right along SRPC
Other Details:
RATCHET EFFECT (or “sticky wages”)
– Prices don’t always go down when AD shifts left due
to: wage contracts, worker morale, minimum wage
laws, “menu costs” – costs to change prices up &
down frequently & fear of “price wars” with
competition.
SHORT RUN – period when wages & other costs are
FIXED (suppliers need time to adjust to change in
AD/AS)