2.1 Aggregate Demand (AD) & Aggregate Supply (AS) - Aggregate Demand Flashcards
What is the formula for AD?
AD = C + I + G + (X - M) or Cd + I + G + X
(Import expenditure has to be removed as AS represents the demand for domestically produced goods and services).
Why is there an inverse relationship between the general price level (GPL) and level of RNY?
Wealth effect: GPL falls - purchasing power of households increases (assume nominal income is constant) - households are better off (income can purchase more goods and services) - consumers are wealthier - consumers are encouraged to spend more - large quantity of goods and services are demanded.
Interest rate effect: GPL falls - households need less money to purchase a fixed quantity of goods and services (assume fixed supply of money) - fall in demand for money - interest rates i.e. price of loans falls - encourages borrowing (households for consumption on interest sensitive items like cars and firms for investments in new plants or equipment) - quantity of goods and services demanded for the uprose of consumption/investment rises.
International substitution effect: Domestic GPL falls (while foreign GPL remains constant) - domestically produced goods are relatively cheaper compared to foreign substitutes (assume CP) - fall in demand for foreign goods - fall in import expenditure. SIMULTANEOUSLY foreigners purchase more of this country’s goods and services that are relatively cheaper - higher quantity of domestically produced goods and services demanded.
How do the non-price determinants of AD affect it?
Show how ΔT, Δlevel of uncertainty, Δwealth, non-price Δinterest rate, Δcorporate tax-rates, Δrate of economic growth, Δexchange rate autonomous ΔG, ΔRNY of trading partners and Δtariffs imposed by other countries affect the four variables that ultimately affect AD.
