Module 17
Apr 2015
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Aggregate demand curve – shows the
relationship between the aggregate price level
and quantity of aggregate output demanded by
households, businesses, the government, and the
rest of the world.
Movements – up or down – indicate a
simultaneous change in the prices of all final
goods and services
Wealth effect of a change in the aggregate price
level – is the change in consumer spending
caused by the altered purchasing power of
consumers’ assets.
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An increase in the aggregate price level, other
things equal, reduces the purchasing power
of many assets.
◦ Ex. If price level increases by 25%, $5000 will have
the purchasing power of what $4000 did. People
will probably cut back on spending.
A fall in the aggregate price level increases the
purchasing power of consumers’ assets and leads to
more consumer demand.
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The interest rate effect of a change in the
aggregate price level is the change in investment
and consumer spending caused by altered
interest rates that result from changes in the
demand for money
In response to an increase in the aggregate price
level, people try to increase its money holdings,
by borrowing or selling assets (like bonds). This
reduces funds available to others and drives
interest rates up which reduces investment
spending. It reduced consumer spending because
people save.
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Changes in expectations – both consumer
spending and investment spending
Changes in wealth – consumer spending
depends in part on the value of household
assets – more $, spend more
Size of the Existing Stock of Physical Capital –
the incentive to spend depends on how much
physical capital they already have – the more
they have, the less they’ll spend
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Government policies and aggregate demand –
the two main ways the government can
influence the aggregate demand curve are
through fiscal policy and monetary policy
Fiscal policy – the use of taxes, government
transfers, or government purchases of goods
and services to stabilize the economy
Government purchases have a direct effect on
the Agg Dem Curve – because of the equation
𝑌 = 𝐶 + 𝐺 + 𝐼 + (𝐸𝑥 − 𝐼𝑚)
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Tax rates and government transfers affect it
indirectly because they influence consumer
spending
Monetary policy – the central bank’s use of
changes in the quantity of money or the interest
rate to stabilize the economy
When the central bank increases the money in
circulation, households have more money –
moves Agg Dem Curve to the right
When the central bank decreases the money in
circulation, households have to borrow – moves
Agg Dem Curve to the left
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1. Determine the effect on aggregate demand
of each of the following events. Explain
whether it represents a movement along the
aggregate demand curve (up or down) or a
shift of the curve (left or right):
A. a rise in the int rate caused by a change in
monetary policy
B. a fall in the real value of money in the
economy due to a higher aggregate price
level
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C. News of a worse-than-expected job
market next year
D. A fall in tax rates
E. A rise in the real value of assets in the
economy due to a lower aggregate price level
F. A rise in the real value of assets in the
economy due to a surge in real estate values
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1. Which of the following explains the slope
of the aggregate demand curve?
◦ I. the wealth effect of a change in the aggregate price level
◦ II. The interest rate effect of a change in the aggregate
price level
◦ III. The product-substitution effect of a change in the
aggregate price level
◦ A. I only
◦ B. II only
◦ C. III only
◦ D. I and II only
◦ E. I, II, and III
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2. Which of the following will shift the
aggregate demand curve to the right?
A. a decrease in wealth
B. pessimistic consumer expectations
C. a decrease in the existing stock of capital
D. contractionary fiscal policy
E. a decrease in the quantity of money
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3. The Consumer Confidence Index is used to
measure which of the following:
A. the level of consumer spending
B. the rate of return on investments
C. consumer expectations
D. planned investment spending
E. the level of current disposable income
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4. Decreases in the stock market decrease
aggregate demand by decreasing which of
the following:
A. consumer wealth
B. the price level
C. the stock of existing physical capital
D. interest rates
E. tax revenues
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5. Which of the following government policies
will shift the aggregate demand curve to the
left:
A. a decrease in the quantity of money
B. an increase in government purchases of
goods and services
C. a decrease in taxes
D. a decrease in interest rates
E. an increase in government transfers
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1. a. Draw a correctly labeled graph showing
aggregate demand
B. on your graph, illustrate an increase in
aggregate demand
C. list the four factors that shift aggregate
demand
D. describe a change in each determinant of
aggregate demand that would lead to the
shift you illustrated in part b