The downward-sloping aggregate demand curve shows the relationship between the price level for outputs and the quantity of total spending in the economy. the aggregate demand curve shows the relationship between the downward slope of the aggregate demand curve illustrates the fact that, other things equal. 4) Aggregate demand is the relationship between the quantity of real GDP 7) The aggregate demand curve shows the ______ relationship between the price.
Unit 5 The Aggregate Demand Curve In Unit 2, we learned that a demand curve illustrates the relationship between quantity demanded and the price of one product. Aggregate demand represents the quantity demanded of all products in a certain country or area at different price levels. It slopes downward because of the substitution effect and because of the income effect. The substitution effect states that as the price of a product decreases, it becomes cheaper than competing products, ceteris paribus, and consumers will substitute the cheaper product for the more-expensive product, and vice versa.
In the case of the aggregate demand curve, we consider all domestic products, so the substitution effect only applies to the substitution of domestic products for foreign products. In other words, when domestic products become cheaper, buyers purchase more of these products and they purchase fewer of the relatively more-expensive foreign products. The income effect states that as the price of a product decreases, buyers will have more income available to purchase more products, and vice versa.
In the case of the aggregate demand curve, if the average price level of all products decreases, buyers will have more discretionary income available. Below is a graph of a typical aggregate demand curve. A shift to the right illustrates an increase in aggregate demand see adjacent graph.
A shift to the left illustrates a decrease in aggregate demand. Anything affecting these components will shift the curve. For example, an increase in wealth and incomes increases aggregate demand. This shifts the curve to the right. Interest rates, expected interest rates and expected rates of return profits affect Gross Private Domestic Investment.
For example, if interest rates decrease, the cost of borrowing decreases. This increases aggregate demand. Government spending is for the most part autonomous. This means that it is not dependent on a particular variable. The government can decide to increase spending on the military or domestic programs. Net Exports is dependent on the relative prices of foreign versus domestic products and exchange rates. If domestic prices decrease, then the demand for our products increases.
The Aggregate Supply Curve In Unit 2, we learned that a supply curve illustrates the relationship between quantity supplied and the price of one product. Aggregate supply represents the quantity supplied of all products in a certain country or area at different price levels. It slopes upward because of the substitution effect and because of the income effect. In the case of the aggregate supply curve, we consider all domestic products, so the substitution effect only applies to the substitution of the production of domestic products in place of the production of foreign products.
In other words, when domestic products can be sold at a higher real price, suppliers will have more incentive to produce domestic products versus foreign products ceteris paribus. If we were to consider a world supply curve, the substitution effect would not apply.
Below is a graph of a typical aggregate supply curve. A shift to the right illustrates an increase in aggregate supply see adjacent graph.
Aggregate Demand (AD) Curve
One can think of the supply of money as representing the economy's wealth at any moment in time. As the price level rises, the wealth of the economy, as measured by the supply of money, declines in value because the purchasing power of money falls. As buyers become poorer, they reduce their purchases of all goods and services. On the other hand, as the price level falls, the purchasing power of money rises.
- Aggregate Demand (AD) Curve
Buyers become wealthier and are able to purchase more goods and services than before. A second reason is the interest rate effect. As the price level rises, households and firms require more money to handle their transactions.
However, the supply of money is fixed. The increased demand for a fixed supply of money causes the price of money, the interest rate, to rise. As the interest rate rises, spending that is sensitive to rate of interest will decline. Hence, the interest rate effect provides another reason for the inverse relationship between the price level and the demand for real GDP.
Section 6: Aggregate Demand and Aggregate Supply
The third and final reason is the net exports effect. Changes in aggregate demand. Changes in aggregate demand are represented by shifts of the aggregate demand curve. An illustration of the two ways in which the aggregate demand curve can shift is provided in Figure.
A shift to the right of the aggregate demand curve. A shift to the left of the aggregate demand curve, from AD 1 to AD 3, means that at the same price levels the quantity demanded of real GDP has decreased. Changes in aggregate demand are not caused by changes in the price level. Instead, they are caused by changes in the demand for any of the components of real GDP, changes in the demand for consumption goods and services, changes in investment spending, changes in the government's demand for goods and services, or changes in the demand for net exports.
Suppose consumers were to decrease their spending on all goods and services, perhaps as a result of a recession.
Then, the aggregate demand curve would shift to the left.