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1. Aggregate Demand

2. The Aggregate Demand (AD) Curve aggregate demand (AD) curve A curve that shows the negative relationship between aggregate output (income) and the price level. Each point on the AD curve is a point at which both the goods market and the money market are in equilibrium.

3. The Aggregate Demand (AD) Curve The Impact of an Increase in the Price Level on the Economy—Assuming No Changes in G, T, and Ms This figure shows that when P increases, Y decreases

4. The Aggregate Demand (AD) Curve The Aggregate Demand (AD) Curve At all points along the AD curve, both the goods market and the money market are in equilibrium. The policy variables G, T, and Ms are fixed.

5. The Aggregate Demand (AD) Curve The Aggregate Demand Curve: A Warning It is important that you realize what the aggregate demand curve represents. The aggregate demand curve is more complex than a simple individual or market demand curve. The AD curve is not a market demand curve, and it is not the sum of all market demand curves in the economy. To understand what the aggregate demand curve represents, you must understand the interaction between the goods market and the money markets.

6. The Aggregate Demand (AD) Curve Other Reasons for a Downward-Sloping Aggregate Demand Curve The Consumption Link The consumption link provides another reason for the AD curve’s downward slope. An increase in the price level increases the demand for money, which leads to an increase in the interest rate, which leads to a decrease in consumption (as well as planned investment), which leads to a decrease in aggregate output (income). The initial decrease in consumption (brought about by the increase in the interest rate) contributes to the overall decrease in output.

7. The Aggregate Demand (AD) Curve Other Reasons for a Downward-Sloping Aggregate Demand Curve The Real Wealth Effect real wealth, or real balance, effect The change in consumption brought about by a change in real wealth that results from a change in the price level.

8. The Aggregate Demand (AD) Curve Shifts of the Aggregate Demand Curve from Policy Variables The Effect of an Increase in Money Supply on the AD Curve An increase in the money supply (Ms) causes the aggregate demand curve to shift to the right, from AD0 to AD1. This shift occurs because the increase in Ms lowers the interest rate, which increases planned investment (and thus planned aggregate expenditure). The final result is an increase in output at each possible price level.

9. The Aggregate Demand (AD) Curve Shifts of the Aggregate Demand Curve from Policy Variables The Effect of an Increase in Government Expenditure G or a Decrease in Net Taxes T on the AD Curve An increase in government spending (G) or a decrease in net taxes (T) causes the aggregate demand curve to shift to the right, from AD0 to AD1. The increase in G increases planned aggregate expenditure, which leads to an increase in output at each possible price level. A decrease in T causes consumption to rise. The higher consumption then increases planned aggregate expenditure, which leads to an increase in output at each possible price level.

10. The Aggregate Demand (AD) Curve Factors That Shift the Aggregate Demand Curve Shifts of the Aggregate Demand Curve from Policy Variables

11. Looking Ahead: Determining the Price Level Our discussion of aggregate output (income) and the interest rate in the goods and money markets is now complete. You should have a good understanding of how the two markets work together. The AD curve is a useful summary of this analysis in that every point on the curve corresponds to equilibrium in both the goods and money markets for the given value of the price level. We have not yet, however, determined the price level.

12. Key Terms • aggregate demand (AD) curve • contractionary fiscal policy • contractionary monetary policy • crowding-out effect • expansionary fiscal policy • expansionary monetary policy • goods market • policy mix • real wealth, or real balance, effect