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AGGREGATE DEMAND

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by

Todd Cota

on 6 May 2015

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Transcript of AGGREGATE DEMAND

AGGREGATE DEMAND: The total demand for a nation's G&S, in a given period of time, at a range of price levels.
I
=
INVESTMENT
FROM FIRMS

G
=DETERMINANTS OF
GOVERNMENT
SPENDING
DETERMINANTS OF GOVERNMENT SPENDING
WHAT IS CAPITAL INVESTMENT?
DETERMINANTS OF INVESTMENTS
capital investments
DETERMINANTS OF INVESTMENTS
DETERMINANTS OF CONSUMPTION
DETERMINANTS OF CONSUMPTION
DETERMINANTS OF CONSUMPTION
1. HOUSEHOLD INCOME
INCREASE IN INCOME = INCREASE IN CONSUMPTION
DECREASE IN INCOME = DECREASE IN CONSUMPTION
3. REAL INTEREST RATES
INTEREST RATES ARE HIGHER = HOUSEHOLDS PREFER TO SAVE MORE & CONSUME LESS
INTEREST RATES ARE LOWER = HOUSEHOLDS PREFER TO CONSUME MORE & SAVE LESS
5. HOUSEHOLD CONFIDENCE
HOUSEHOLDS CONFIDENCE ABOUT FUTURE INCOMES OR EMPLOYMENT OPPORTUNITIES CHANGES = INCREASE OR DECREASE IN SPENDING = HIGHER CONSUMPTION

6. INFLATION
CHANGE IN AVERAGE PRICE LEVEL = INCREASE OR DECREASE IN SPENDING

7. DEMOGRAPHIC CHANGES
CHANGES IN AGE OF POPULATION CAUSES A CHANGE IN SPENDING
1. REAL INTEREST RATES
LOWER INTEREST RATES = FIRMS BORROW MORE MONEY & BUY NEW CAPITAL EQUIPMENT
HIGHER INTEREST RATES = FIRMS BORROW LESS MONEY & BUY LESS CAPITAL EQUIPMENT
1. FISCAL POLICY
LEVEL OF TAXATION & GOVERNMENT SPENDING
LOWER TAXES = EXPANSIONARY SHIFT OF AD CURVE
CAUSES DISPOSABLE INCOME TO RISE FOR HOUSEHOLDS AND FIRMS
INCREASES SPENDING
INCREASES GDP
2. GOVERNMENT DEBT
HIGHER DEBT = MORE GOVERNMENT SPENDING IN THE SHORT-RUN, WITH DEBT BEING PAID OFF IN THE LONG-RUN
TAXES HAVE TO BE RAISED & GOVERNMENT SPENDING FALL
2. WEALTH
VALUE OF ASSETS - LIABILITIES
STOCKS/BONDS/PROPERTY OWNERSHIP
INCREASE IN VALUE = HOUSEHOLDS FEEL RICHER = INCREASE IN CONSUMPTION
DECREASE IN VALUE = HOUSEHOLDS FEEL POORER = DECREASE IN CONSUMPTION
4. HOUSEHOLD DEBT
HIGH DEBT = ALLOCATE MORE INCOME TO PAY OFF DEBTS = CONSUMPTION FALLS
LOW DEBT = ALLOCATE LESS INCOME TO PAY OFF DEBTS = CONSUMPTION RISES
DETERMINANTS OF GOVERNMENT SPENDING
DETERMINANTS OF NET EXPORTS
1. A CHANGE IN FOREIGN CONSUMERS INCOME
FOREIGN NATIONAL INCOMES RISE = DEMAND FOR TRADING PARTNERS EXPORTS INCREASE = A POSITIVE CHANGE IN NET EXPORTS
DOMESTIC NATIONAL INCOMES INCREASE = DEMAND FOR TRADING PARTNERS IMPORTS INCREASE = A NEGATIVE CHANGE IN NET EXPORTS
DETERMINANTS OF NET EXPORTS (X-M)
2. DOMESTIC INCOMES RISE
DOMESTIC INCOMES INCREASE = BUY MORE FOREIGN GOODS = NET EXPORTS DECREASE
DOMESTIC INCOMES DECREASE = BUY LESS FOREIGN GOODS = NET EXPORTS INCREASE
DETERMINANTS OF NET EXPORTS (X-M)
DETERMINANTS OF NET EXPORTS (X-M)
3. EXCHANGE RATES
DOMESTIC CURRENCY GETS STRONGER = EXPORTS MORE EXPENSIVE TO FOREIGN CONSUMERS = NET EXPORTS FALL
DOMESTIC CURRENCY GETS WEAKER = EXPORTS ARE CHEAPER TO FOREIGN CONSUMERS = NET EXPORTS RISE

4. CHANGES IN TRADE POLICIES/BARRIERS (LEVEL OF PROTECTIONIST POLICIES
(TARIFFS/QUOTAS)

5. INFLATION RATE
If consumers expect higher inflation in the future, then they increase consumption expenditures in the present.
If consumers expect lower inflation in the future, then they decrease consumption expenditures in the present.
(
X-M
)
DETERMINANTS OF:
EXPORTS - IMPORTS =
NET EXPORTS
Government Interventionist Policies to affect Aggregate Demand
1. FISCAL POLICY
2. MONETARY POLICY

Government policies related to spending & taxation which is used to change consumer's disposable income.
Direct Tax (Income tax)
Indirect Tax (Expenditure tax on G&S)

TWO TYPES OF FISCAL POLICY
1) EXPANSIONARY FISCAL POLICY
(C) lower income tax
= increased disposable income = increased consumption = Increased AD
(I) lower corporate tax =
increased profits = increased investment
(G) Increase govt spending (capital investment, etc.) =
increase improvements in public infrastructure/services
2) CONTRACTIONARY FISCAL POLICY
(C) Increase income tax =
decreased disposable income = decreased consumption = decreased AD = cooling inflationary pressure)
(I) Increased corporate tax =
decreased profits = decreased investment = slowing down inflationary pressure
(G) Decreased govt spending (capital investment, etc.) =
decreased improvements in public infrastructure/services = decrease in inflationary pressure
Government Budget
Government Expenditures
Three categories of public spending
1) Capital expenditures
highway expansion/repair
building/expansion/repair of schools, hospitals, etc.
2) Current expenditures
wages for govt employees
public institution supplies
3) Transfer Payments
government benefits
pensions
child support
disability
Government Income
Sources:
income taxes
social security payments (firms & households
corporate taxes
indirect taxes
tariffs
publicly owned companies profits
sale of public company
rental income of public property
Government National Budget
Budget & Expenditures (Fiscal Stance)
budget surplus = earn more than spent
budget deficit = spend more than earned
balanced budget = spending equals earnings
Government Finance of Budget Deficit
Governments borrow money via the sale of government issued bonds
bonds sold to:
households
firms
foreign households, firms & governments
MONETARY POLICY:
Official policies governing the supply of money & level of interest rates in the economy
Changes in central bank's prime rate (base rate/discount rate) affect the level of AD in the economy.
Expansionary (Loose)Monetary Policy:
lower the rate = reduction to cost of borrowing money = increase C & I = increase in AD = increase in National Output
Contractionary (Tight) Monetary Policy:
increase the rate = increase in cost of borrowing money = decrease C & I = decrease in AD = decrease in National Output
Form Pairs and Answer the Questions Below

1. Of the various types of expenditures, which one could possibly be recorded as a negative figure in nation's GDP measurement? How could it be negative?

2. Assume a government wishing to balance its budget does so by shutting down several military bases in locations around the country. Explain the impact this policy will have on GDP.

3. Assume a government reduces the income tax rate on households and businesses. Explain the impact this policy will most likely have on GDP.

4. Suppose that the central bank (which controls the interest rates in an economy) wishes to stimulate GDP growth. Should the central bank raise or lower interest rates, and why?

5. When a nation's currency appreciates (becomes more valuable in terms of other currencies), its GDP tends to fall. Why is this the case?
GDP Practice Activity (Q & A)
1. Of the various types of expenditures within a nation’s GDP, which one could possibly be recorded as a negative figure in a nation's GDP measurement? How could it be negative?
Net exports could be negative, if a country spends more on imported goods and services than it earns from the sale of its exports to the rest of the world.

2. Assume a government wishing to balance its budget does so by shutting down several military bases in locations around the country. Explain the impact this policy will have on GDP.
Shutting down military bases will reduce the nation’s GDP, since military spending is a type of government spending, the “G” component of the expenditure approach will decrease. The soldiers and other military support staff who lose their jobs will not have incomes, therefore household consumption will also likely decrease.

3. Assume a government reduces the income tax rate on households and businesses. Explain the impact this policy will most likely have on GDP.
Lower taxes on households will leave Americans with more disposable income, some of which they will use to consume more goods, increasing household consumption and contributingto GDP. Lower taxes on businesses will encourage firms to invest in new capital, increasing domestic investment, also contributing to GDP.

4. Suppose that the central bank (which controls the interest rates in an economy) wishes to stimulate GDP growth. Should the central bank raise or lower interest rates, and why?
If the central bank wishes to stimulate GDP, it should lower the interest rate in the economy. Lower interest rates will encourage businesses to borrow money and invest in new capital, increasing domestic investment. Lower interest rates will also discourage savings among households, who will instead choose to consume with more of their income. Increased investment and consumption lead to a higher GDP.

5. When a nation's currency appreciates (becomes more valuable in terms of other currencies), its GDP tends to fall. Why is this the case?
GDP falls when the currency appreciates because foreigners find that country’s exports more expensive, and domestic consumers fine imports cheaper. The increase in imports and decrease in exports causes net exports to fall, reducing the nation’s GDP.
C
= HOUSEHOLDS DEMAND FOR GOODS & SERVICES FOR
CONSUMPTION
2. EXPECTATIONS OF FIRMS (CONFIDENCE LEVEL)
FIRMS INCREASE IN CONFIDENCE ABOUT FUTURE BUSINESS OPPORTUNITIES = HIGHER CAPITAL INVESTMENT.
FIRMS DECREASE IN CONFIDENCE ABOUT FUTURE BUSINESS OPPORTUNITIES = LOW CAPITAL INVESTMENT
CAPITAL INVESTMENT
SPENDING ON CAPITAL GOODS
NEW FACTORIES
NEW BUILDINGS
NEW MACHINERY
NEW VEHICLES
NEW INVESTMENT OFTEN INCLUDES ADVANCES IN TECHNOLOGY
CAN ALSO INCLUDE IMPROVING HUMAN CAPITAL OF WORKFORCE THROUGH TRAINING / EDUCATION TO IMPROVE SKILLS AND ABILITIES
GOVERNMENT SPENDING: CAPITAL INVESTMENTS
FISCAL POLICY
Watch the Video on Government Bonds
NATIONAL OUTPUT = C+I+G+(X-M)
BALANCE OF PAYMENTS (NET EXPORTS)
MOVEMENTS ALONG
& SHIFTS OF THE AD CURVE
Movements
along the curve:
Changes in the price level
Shifts
in the AD curve are caused by a Change In:
CONSUMER SPENDING:
change in wealth
expectations about future income & prices
interest rates (due to monetary policy)
personal income taxes (due to fiscal policy)
level of household indebtedness
attitude towards spending
Shifts
in the AD curve are caused by a Change In:
INVESTMENT SPENDING
expectations about future sales
improvement in technology
interest rates (due to monetary policy)
business taxes (due to fiscal policy)
legal/institutional changes

Shifts
in the AD curve are caused by a Change In:
GOVERNMENT SPENDING:
Political priorities
deliberate efforts to influence aggregate demand ( due to fiscal policy)
Shifts in the AD curve are caused by a Change In:
FOREIGNERS' SPENDING:
change in real national income
change in exchange rates
Full transcript