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Aggregate Demand
The aggregate demand is the total demand for all the goods and services provided in the economy.
Why Does the Aggregate-Demand (AD) Curve Slope Downward?
1. The Wealth Effect: A higher price level
decreases
real wealth, which causes a decrease
in consumption and AD. 2. The Interest Rate Effect: A higher price level
increases
the interest rate, which decreases
spending on investment and AD.3. The Real Exchange-Rate Effect: This is also called the substitution effect or the foreign trade effect. A higher price level causes the real exchange rate to
appreciate
, which decreases
net exports and AD. All three of these factors lead to a movement along the AD curve.
Shifts in AD
- Shifts Arising from Changes in Consumption: An event that makes consumers spend more at a given price level (a tax cut or a stock market boom) shifts AD to theright.
- Shifts Arising from Changes in Investment: An event that makes firms invest more at a given price level (optimism about the future or a fall in interest rates) shifts AD to theright
- Shifts Arising from Changes in Government Purchases: An increase in government purchases of goods and services (greater spending on defence or highway construction) shifts AD to theright.
- Shifts Arising from Changes in Net Exports: An event that raises spending on net exports at a given price level (a boom experienced by a major trading partner) shifts AD to theright.
