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Aggregate Demand and Aggregate Supply Model

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A model that explains short-run fluctuations in real GDP and the price level.

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short run

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In the _, real GDP and the price level are determined by the intersection of the aggregate demand curve and the short run aggregate supply curve.

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real GDP, price level

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In the Aggregate Demand and Aggregate Supply Model, _ is measured on the horizontal axis, and the _ is measured on the vertical axis by the GDP deflator.

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short run fluctuations

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1. Economy's output of goods and services, as measured by the real GDP. 2. Average level of prices, as measured by the GDP deflator.

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Aggregate Demand

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Curve that shows the various amounts of real domestic output that domestic and foreign buyers will desire to purchase at each price level.

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price level

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Aggregate demand shows the relationship between the _ and the quantity of real GDP demanded by households, firms, and the government. The Aggregate Demand formula is Y=C+I+G+NX

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1. Real balances effect or wealth effect

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Why does the AD slopes downward?: A decrease in the price level raises the real value of money and makes consumers wealthier, which in turn encourages to spend more (larger quantity demanded)

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lower

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Why does the AD slopes downward? The Interest rate effect: A _ price level will decrease the interest rate and increase investment spending, thereby increasing the quantity of goods and services demanded.

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higher

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Why does the AD slopes downward? The Interest rate effect: A _ price level increases the interest rate and reduces investment spending, thereby reducing the quantity of goods and services demanded.

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Foreign Purchases Effect

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Why does the AD slopes downward? When price level falls, other things equal, U.S. prices will fall relative to foreign prices, which will tend to increase spending on U.S. exports and also decrease import spending in favor of U.S. products that compete with imports. Net exports increase - Quantity demanded increases.

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Aggregate Demand Curve

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Relationship between the price level and the quantity of real GDP demanded, holding constant everything else.

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Movement

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Aggregate Demand Curve: Changes in price level causes _ along a stationary demand curve. We refer to changes in "quantity demanded".

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shift

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Aggregate Demand curve: The curve will _ if any variable changes other than the price level. We refer to changes in "demand".

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consumer

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Why the aggregate demand curve might shift? Changes in _ spending

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Consumer wealth

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(changes in consumer spending) includes financial and physical assets. Increase in the real value of consumer wealth; save less buy more.

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Stock Market boom, right (Under consumer wealth)

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Causes an Increase in wealth and less concern about saving, Increase of Quantity of goods and services demanded at any given price level, and a shift to the _ of the aggregate demand curve

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future income, right

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Consumer expectations: Causes an increase in _, increase in current consumption spending (spend more of their current income), and a shift to the _ of the aggregate demand curve

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inflation

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Consumer Expectations: Increases Future _, Increase spending (consumer will want to buy before prices go up), Shift right to the aggregate demand curve

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Household Debt

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Finance their current spending and borrowing. Increase debt, Increase current consumption spending, shift right aggregate demand

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Cut Taxes

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Personal taxes (government): Increase Consumer Spending, Shift right of aggregate demand.

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Raises Taxes

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Personal taxes (government): Decrease in consumer spending, shift left aggregate demand

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Saving for retirement

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Decrease in current consumption, decrease in quantity of goods and services demanded at any price level, shift left aggregate demand curve

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Stock market boom

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Makes people wealthier and less concerned about saving. Increase in current consumption, increase quantity of goods and services demanded at any price level, shift right aggregate demand curve

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Consumer wealth (CW)

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CW Increases, AD Increases. If CW decreases, AD decreases

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Consumer Expectations (CE)

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If CE increase, AD increases. If CE decreases, AD decreases

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Household debt (HD)

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If HD increase, AD increases. HD decreases, AD decreases.

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Personal taxes (PT)

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PT increases, AD decreases. PT decreases, AD increases.

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Technology

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If improved technology increases, expected returns aggregate demand shifts to right

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Optimistic Expected Future Business Conditions

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Return increases, Investment Increases, AD increases

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Pessimistic Expected Future Business Condition

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Return decreases, investment decreases, AD decreases

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Degree of excess capacity (Unused Capital): Excess Increases

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Expected return on new investment decreases, AD decreases. Firms operating below capacity have little incentive to build new factories.

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Degree of excess (unused capital): Excess Decreases

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Excess return on new investment in factories and capital investment increases, investment increases, aggregate demand shifts to the right

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Real Interest Rates (i)

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i Increases then AD decreases. i decreases AD increases.

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Profit expectation on projects (PE)

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PE increases AD increases. PE decreases AD decreases.

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Business taxes (BT)

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BT increases AD decreases. BT decreases AD increases.

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State of Technology (Tech)

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Tech increases AD increases. Tech decreases AD decreases.

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Excess capacity (EC)

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EC increases AD decreases. EC decreases AD increases.

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Change in Government Spending

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Increases government purchases or expenditures, Increases Quantity of goods demanded at any price level, shifts aggregate demand to the right.

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Change in net exports

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NX=Exports-Imports

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National Income Abroad (change in net exports)

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Rising National Income abroad. Net exports rise (i.e. exports rise). Aggregate Demand shifts to the right.

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Changes in exchange rates (change in net exports)

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Dollar depreciates (relative lower value). US exports rise, US imports decline: NX increase. Aggregate demand shifts to the right.

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National Income abroad (NI)

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NIA increases then AD increases. NI decreases then AD decreases.

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Exchange rates

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USD appreciates then AD decreases. If USD depreciates then AD increases.

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Domestic currency depreciates

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(exports increase-imports decrease). Prices for goods and services from that country become more attractive and the demand for them will rise. Imports become more costly as it takes more currency to buy goods and services.

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Domestic Currency Appreciates

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(Exports decrease-imports increase)

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Money supply changes (Government Actions)

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Increase in money supply leads to a decrease in interest rate in the short run, borrowing is less costly, stimulates investment, and aggregate demand shifts to the right.

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Fiscal policy (government actions)

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Increase in government purchases, increases AD. Decreases in taxes, increases AD.

Economics Chapter 13 Notes Aggregate Demand – Flashcards

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