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Notes on the aggregate demand and aggregate supply curves

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Introduction

Notes on the aggregate demand and aggregate supply curves The shape of the aggregate demand curve is downward sloping. What does it mean when we say the curve is downward sloping? Simply put, as the average price of all the goods and services produced increases, the quantity of all the goods and services produced decreases. Average price of all the goods and services = this could be measured by the inflation rate The quantity of all the goods and services = this could be measured through the GDP In other words when the aggregate demand curve is downward sloping, an increase in inflation causes the GDP to fall (holding the supply of goods and services produced constant). First who demands goods and services? Why is the aggregate demand curve downward sloping? 3 theories 1. International effect as the price of American goods increases, Americans purchase relatively more foreign goods, exports fall, imports rise, GDP falls. 2. Asset effect the purchasing power of individuals (which is based on their wealth) falls. They are unable to buy as much so consumption falls. ...read more.

Middle

Present income is the amount a person earns now. Future or permanent income is the expected earnings over a lifetime. Another factor that impacts the amount a person earns is his/her family income. Families make spending decisions together. Interest rates also affect consumption. Low interest rates inspire spending. Confidence in the economy and employment enables consumption. Tax rates directly affect that amount of money available for consumption. When personal taxes increase, disposable income decreases causing consumption to fall. Savings preferences impact consumption. Increases in savings decreases consumption. Some societies are more prone to save than others. Some age groups are more apt to save than others. Intertemporal decisions impact today's consumption as well. Life Cycle Hypothesis. Investment What is investment? An increase in business investment will lead to an increase in aggregate demand. When the aggregate demand curve increases the GPD increases, the unemployment rate falls, and inflation rises. What are the factors that effect investment? interest rates (-) corporate profits (+) expectations of future demand for the product (?) expansion opportunities (+) According to Keynes how can the government control investment? ...read more.

Conclusion

A summary of the graphical process, an increase in the money supply causes interest rates to decrease. When interest rates decrease, investment rises. When investment rises the aggregate demand curve shifts right. GDP increases, unemployment falls, inflation rises. Government Spending according to Keynes if the government increases spending, gdp will increase by the amount of government spending times the multiplier. ie if the multiplier is 3, if the government increases their spending by $1000 then gdp will rise by $3000. The multiplier can be measured in two ways 1. the change in gross domestic product/ the change in government spending multiplier = 3000/1000 = 3 What are the downfalls of government spending higher deficits higher taxes higher interest rates disincentive to work what should the government spend their money on? Keynes summary An increase in taxes causes a decrease in disposable income. This causes a decrease in consumption, and a decrease (shift left) of the aggregate demand curve An increase in the money supply causes a decrease in interest rates, which causes an increase in investment. The increase in investment causes an increase in the aggregate demand curve. An increase in government spending directly increases the aggregate demand curve. The three government tools are taxes, money supply and government spending. ...read more.

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