1. Foundations: Aggregate Demand (AD)
Definition: A curve showing the relationship between the price level and the total quantity of
real GDP demanded by all sectors (C, I, G, NX).
The Three Reasons for the Downward Slope
● Real-Balances Effect: If prices rise, the purchasing power of your savings/cash drops.
You feel poorer and spend less (C downarrow).
● Interest-Rate Effect: Higher prices increase the demand for money, which raises
interest rates. This makes borrowing for cars or factories expensive (I downarrow and C
downarrow).
● Foreign-Purchases Effect: If U.S. prices rise relative to foreign prices, U.S. goods
become expensive. Exports fall and imports rise (NX downarrow).
The AD Equation and Shifters
The curve shifts if any component changes for reasons other than the price level:
Y = C + I + G + NX
● Consumption ($C$): Shifted by consumer wealth, expectations, household debt, or
personal taxes.
● Investment ($I$): Shifted by interest rates and "Expected Returns" (business
confidence).
● Government ($G$): Shifted by changes in federal, state, or local spending (e.g.,
building a bridge).
● Net Exports ($NX$): Shifted by foreign income levels and exchange rates (Appreciation
= Left shift; Depreciation = Right shift).
2. Foundations: Aggregate Supply (AS)
Definition: A curve showing the relationship between the price level and the total quantity of
real GDP demanded by all sectors (C, I, G, NX).
The Three Reasons for the Downward Slope
● Real-Balances Effect: If prices rise, the purchasing power of your savings/cash drops.
You feel poorer and spend less (C downarrow).
● Interest-Rate Effect: Higher prices increase the demand for money, which raises
interest rates. This makes borrowing for cars or factories expensive (I downarrow and C
downarrow).
● Foreign-Purchases Effect: If U.S. prices rise relative to foreign prices, U.S. goods
become expensive. Exports fall and imports rise (NX downarrow).
The AD Equation and Shifters
The curve shifts if any component changes for reasons other than the price level:
Y = C + I + G + NX
● Consumption ($C$): Shifted by consumer wealth, expectations, household debt, or
personal taxes.
● Investment ($I$): Shifted by interest rates and "Expected Returns" (business
confidence).
● Government ($G$): Shifted by changes in federal, state, or local spending (e.g.,
building a bridge).
● Net Exports ($NX$): Shifted by foreign income levels and exchange rates (Appreciation
= Left shift; Depreciation = Right shift).
2. Foundations: Aggregate Supply (AS)
