Chapter 12: Aggregate Demand and Aggregate Supply Flashcards
What is the aggregate demand curve?
A graphical representation that shows the relationship between the aggregate price level and the quantity of aggregate output demanded by households, firms, the government, and the rest of the world.
Why does the aggregate demand curve have a negative slope?
Due to the wealth effect of a change in the aggregate price level and the interest rate effect of a change in the aggregate price level.
Why does the aggregate demand curve slope downwards?
The negative relationship between the aggregate price level and the quantity of aggregate output demanded (i.e., aggregate price level goes up, demand for aggregate output goes down)
When we consider movements up or down the aggregate demand curve, we’re considering…
A simultaneous change in the prices of all final goods and services
What is the wealth effect (of a change in the aggregate price level)?
The effect on consumer spending caused by the change in purchasing power of consumers’ assets when the aggregate price level changes. A rise in the aggregate price level decreases the purchasing power of consumers’ assets, so consumers decrease their consumption; a fall in the aggregate price level increases the purchasing power of consumers’ assets, so consumers increase their consumption.
What is the interest rate effect (of a change in the aggregate price level)?
The effect on consumer spending and investment spending caused by a change in the purchasing power of consumers’ money holdings when the aggregate price level changes. A rise (fall) in the aggregate price level decreases (increases) the purchasing power of consumers’ money holdings. In response, consumers try to increase (decrease) their money holdings, which drives up (down) interest rates, thereby decreasing (increasing) consumption and investment.
What does the aggregate demand curve do in relation to the income-expenditure model?
It’s a way to summarize what the income-expenditure model says about the effects of changes in the aggregate price level.
A movement down the AD curve…
Leads to a lower aggregate price level and higher aggregate output.
When does a rightward shift of the AD curve occur?
When the quantity of aggregate output demanded increases at any given price level (we call this an increase in demand or a positive AD shift).
When does a leftward shift of the AD curve occur?
When the quantity of aggregate output demanded falls at any given price level (we call this a decrease in demand or an adverse/negative AD shift).
What are the most important factors that can cause a shift in the aggregate demand curve?
Changes in expectations, changes in wealth, the size of the existing stock of physical capital, fiscal policy (contractionary and expansionary), and monetary policy (contractionary and expansionary).
When consumers and firms become more optimistic…
Aggregate demand increases
When consumers and firms become more pessimistic…
Aggregate demand decreases
When the real value of household assets rise…
Aggregate demand increases
When the real value of household assets fall…
Aggregate demand decreases
When the existing stock of physical capital is relatively small…
Aggregate demand increases
When the existing stock of physical capital is relatively large…
Aggregate demand decreases
When the government increases spending or cuts taxes…
Aggregate demand increases
When the government reduces spending or raises taxes…
Aggregate demand decreases
When the central bank increases the quantity of money supplied…
Aggregate demand increases
When the central bank reduces the quantity of money supplied…
Aggregate demand decreases
Why do changes in expectations cause a shift in the aggregate demand curve?
Both consumer spending and planned investment spending depend on people’s expectations about the future. Consumers base their spending not only on the income they have now but also on the income they expect to have in the future. Firms base their planned investment spending not only on current conditions but also on the sales they expect to make in the future. As a result, changes in expectations can push consumer spending and planned investment spending up or down. If consumers and firms become more optimistic, aggregate expenditure rises; if they become more pessimistic, aggregate expenditure falls (due to a decrease in autonomous consumption and/or autonomous investment).
Which surveys do forecasters pay attention to concerning consumer and business sentiment?
Index of Consumer Confidence (monthly) and Index of Business Confidence (quarterly), both from the Conference Board of Canada, and the Business Outlook Survey (quarterly) from the Bank of Canada.
Why do changes in wealth cause a shift in the aggregate demand curve?
Consumer spending depends in part on the value of household assets. When the real value of these assets rises, the purchasing power they embody also rises, leading to an increase in aggregate expenditure (and an increase in aggregate demand).