Summary EKN 120: CHAPTER 14 NOTES

AGGREGATE DEMAND SHIFTS AND AGGREGATE
CHAPTER 14 EXPENDITURES MODEL
the keynesian cross • when there is a change in one of the
determinants of aggregate demand, the
aggregate expenditures schedule shifts
AGGREGATE DEMAND
upward or downward
• aggregate demand: schedule/curve that
• a – change in some determinant other than
shows the total quantity of goods + services
price level shifts aggregate expenditures
demanded at different price levels
schedule upward from AE1 to AE2
• inverse relationship between price level and
• multiplier increases real output from Q1 to Q2
amount of real GDP demanded
• b -the counterpart of this change is an initial
o when price level rises, quantity of real
rightward shift of the aggregate demand
GDP demanded decreases
curve by the amount of initial new spending
o when price level falls, quantity of real
• this leads to a multiplied rightward shift of
GDP demanded increases
the curve to AD2, which is just sufficient to
show the same increase of real output as that
DERIVATION OF AGGREGATE DEMAND CURVE FROM in the expenditures model
AGGREGATE EXPENDITURES MODEL
• horizontal axes measure real GDP
• a – rising price levels from P1 to P2 to P3 shift
aggregate expenditures curve downward
from AE1 to AE2 to AE3 and reduce real GDP
from Q1 to Q2 to Q3
• b – aggregate demand curve AD is derived by
plotting successively lower real GDPs from
upper graph against the P1, P2 and P3 price
levels
• increases in price level will shift its aggregate
expenditures schedule downward and will
reduce real GDP




THE AGGREGATE DEMAND CURVE INVERSE
RELATIONSHIP
• downward sloping aggregate demand curve
indicates inverse relationship between price
level and amount of real output purchased




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, REAL BALANCES EFFECT • changes in aggregate demand involve two
• the tendency for increases in the price level components:
to lower the real value of financial assets o change in one of determinants that
with fixed money value and, as a results, to directly changes amount of real GDP
reduce total spending and real output, and demanded
conversely for decreases in the price level o multiplier effect that produces
greater ultimate change in aggregate
INTEREST RATE EFFECT demand than initiating change in
• the tendency for increases in the price level spending
to increase the demand for money, raise
interest rates and, as a result, reduce total DETERMINANTS OF DEMAND
spending and real output in the economy, and 1. Change in consumer spending
the reverse for price-level decreases • when price level is constant, consumers may
alter their purchases of produced real output
FOREIGN PURCHASES EFFECT • if consumers decide to buy ,ore output at
• the inverse relationship between the net each price level, aggregate demand curve
exports of an economy and its price level will shift to the right, from AD1 to AD2
relative to foreign price levels • if they decide to buy less output, the
aggregate demand curve will shift to the left
CHANGES IN AGGREGATE DEMAND from AD1 to AD3
• other things being equal, change in price 1.1 Consumer wealth
level will change amount of aggregate • financial + physical assets
spending and therefore change amount of • increase in real value of consumer wealth
real GDP demanded by economy prompts people to save less + buy more
• movements along fixed aggregate demand products (wealth effect)- shift aggregate
curve represent these changes in real GDP demand curve to the right
• decrease in real value of consumer wealth at
FACTORS THAT SHIFT THE AGGREGATE DEMAND each price level will reduce consumption
CURVE spending (negative wealth effect) – shift
aggregate demand curve to the left
1.2 Consumer expectations
• when people expect future income to rise,
they tend to spend more of current income
• current consumption spending increases and
the aggregate demand curve shifts to right
• expectation of surging inflation in future may
increase aggregate demand today because
consumers will want to buy products before
• a change in one or more determinants will their prices escalate
shift aggregate demand curve • expectations of lower future income/prices
• rightward shift from AD1 to AD2 represents an reduce current consumption – shift to left
increase in aggregate demand 1.3 Household debt
• leftward shift from AD1 to AD3 shows a
• increased household debt – increased
decrease in aggregate demand
consumption – shifts curve to the right
• vertical distances between AD1 and dashed
• reduced household debt – consumption
lines represent initial changes in spending
spending + aggregate demand decline

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