Lecture 12
AGGREGATE DEMAND

1. Derivation

• Start with the income-expenditure diagram

• As P increases, the AE-line shifts down (Why?)
  • Real-balance effect:
    Increase in the price level reduces the real value of fixed-income assets ...
    ... causing households to feel poorer and cut back on their spending

  • Effect on net exports:
    Increase in P causes our exports to fall and imports to rise

• For different values of P, trace out corresponding Y

• Voila! A negatively-sloped aggregate demand curve! (Denoted by AD or DD)

2. Shift of the DD curve

• Increase in aggregate expenditure is the same as an increase in aggregate demand

• Anything that causes AE to rise will cause DD to shift to the right, except ...
  ... The price level (Not a parameter for the DD curve!)

2.1 Parameters of the DD curve

• Real interest rates:
  Higher R leads to decrease in C and I

• Taxes:
  Higher T leads to decrease in C

• Government expenditure:
  Higher G leads to increase in AE

• Foreign GDP:
  Higher Y* leads to increase in U.S. net exports

• Exchange rates:
  Stronger U.S. dollar leads to reduction in U.S. net exports