Alright. So let's start a discussion about another economic model here. The aggregate demand and aggregate supply model. So we're gonna shorten it to the A. D. A. S. Model like you see here A. D. A. S. Model for aggregate demand, aggregate supply. So we're gonna start here with aggregate demand. Okay. And what this model attempts to explain is short run fluctuations in GDP and price. So a lot of what you see here is actually gonna mimic what we learned when we were talking about market demand and market supply. But now we're taking it to the economy as a whole. So instead of just talking about say the market for corn or the market for hamburgers, we're talking about the entire uh goods market in general. Okay. So let's start here with aggregate demand. So all the demand there is in the economy. And we're gonna call that the A. D. So we have A D. A. S. Model A. D. Is the aggregate demand. So aggregate demand is closely related to our calculation of GDP and recall that GDP is consumption plus investment plus government purchases plus net exports. Right? That's how we were defining G. D. P. When we talk about aggregate demand, what are the people demanding things? We've got the consumption right? The consumers consuming goods and services, the firm's consuming things are investing in products as well. Right? Everything that's being demanded here, the government demanding things and then uh foreigners demanding as well. So when we talk about aggregate demand, it follows the same rules as demand in a single market. Remember the rule that we've been using when we were talking about demand. The downward demand. The double Ds. Well guess what? It still holds true in this case. So when we're talking about aggregate demand you can use your double D. Uh pneumonic as well here. Alright. So the double Ds. So what does that tell us? Remember downward demand? So as price levels fall and notice this is price levels in the economy as a whole, not just the price of wheat or the price of hamburgers, right? It's not just one product, it's as price levels that C. P. I. And the entire economy as it falls. Well the quantity of real GDP demanded increases, right? There's this inverse relationship. So the lower the prices are the more goods and services we're gonna want. So when we think of the aggregate demand curve and we look at it on the graph, well it's gonna look similar to that demand curve we drew in a market except we're talking about the economy as a whole. Right? So here on the on the y axis we're gonna have the price level. So notice it's not just price um of one good, it's the price level in the economy. And over here we're gonna have GDP right? And it's gonna be real GDP because we're talking about the amount of goods and services were focused on that quantity. So this G. D. P. Is kind of like quantity and the price level is kind of like price in the other graph. Alright. So that's very similar to the graph we're used to and our downward demand. Well it's gonna look something like this just like it did before we're gonna have our demand curve going down like this and this will be our aggregate demand which we're calling A. D. Right in this model it's the A. D. The aggregate demand. Alright. So that should feel a little familiar from when we first studied supply and demand. Let's pause here and then we'll discuss some of the differences in how market demand and aggregate demand work.
Aggregate Demand Downward Sloping
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So now that we're dealing with aggregate demand, we're gonna need macroeconomic solutions for why that demand curve is going downward, like we saw above. Okay so at first let's think about that single market before when we were talking about a single market demand in the early chapters, right? A single market when we saw the quantity demand fall as price increases because customers substituted their demand right? They were able to substitute their demand to some other good. So if the price of apples went up well then they buy oranges instead, right? Buy oranges instead so they would substitute for other products. However, when we're thinking about all of the products, well we can't separate apples from oranges anymore. Now they're all part of the goods, right? When we're talking about aggregate demand in the whole economy. Well, if you substitute apples for oranges, well that's included in aggregate demand. You see what I'm saying? Aggregate demand includes everything already. So there can't be any substitution effect. So what we have to think about is how um the demand is affected from each of its components. Remember we said the the demand is very closely related to G. D. P. The amount of things demanded in the society, not just Apple's not just oranges but the amount of things demanded. So it's going to be affected by consumption, it's going to be affected by investment and it's going to be affected by government spending and net exports. So let's start here with consumption. The one related to consumption is what we call the wealth effect. The reason that we have downward demand Um One of the reasons here is how it affects consumption. So the wealth effect tells us that the price level when the prices change, well we can't buy as many goods and this might be similar to what we discussed in a market demand with the income effect. And it is this is very similar because when we're talking about market demand, we were talking about consumption in a lot of sense is but this is extending that to also investment and these other things government and net exports as well. Right? So this wealth effect An example here, if you have $1, right? And candy costs $1, you can buy one candy, right? But if you have $1 and candy costs 50 cents, well now you can buy two candies, right? So the price level clearly affects how much you're able to consume in quantity. Right? So as the price levels decrease here, right? We're seeing the price levels decrease and we're able to buy more goods, right? The quantity demanded is going to increase. So price levels decrease, the real value of money increases. And what does it mean to say real value the quantity you can purchase, right? When we think of real values quantity, I'll say purchase a ble so the quantity, purchase a ble is going up, right? So when we talk about real, when we're thinking about real, remember that we're holding prices constant in those situations were saying the value, um how much value are we able to get with that dollar? Well, at first we were only able to get one candy bar, but now we can get two candy bars with that same amount of money. Right? So the wealth effect tells us that as the prices go down, we're able to afford more things, right? And the opposite, as the prices go up, we're afford less. So the real value amount of money increases, allowing you to purchase more goods when that price decreases, so that quantity demanded goes up as price levels go down. So now let's think about the next one investment. So the investment is going to be related to interest rates a lot, because interest rates describe how price levels are gonna affect investment here. Okay, so this is the interest rate effect and in this case, well, when the prices decrease, right, the households are able to save more money, so with a lower price, think about it. If if there's a lower price, that means we're able to spend less on same amount of goods. So, if we're able to spend less on those same amount of goods, well, we can save some more money, or we could purchase more goods, but as we've seen with consumption, right, there's that marginal propensity to consume marginal propensity to save. So if those prices are lower, we're able to save a little bit more money as well. So when the households are saving more money, well, now there's more supply, there's more supply of savings into, into the financial system. And since there's more financial, uh, more more savings available, the interest rates are gonna fall, right? Because more people are saving, Well, there's less of a demand for there's there's less of a need for people to save. Um So, those those interest rates are gonna fall because of the increased savings and when those interest rates fall, Well, guess what? Investment spending goes up, right? Because firms need that money, firms are the ones demanding money to make to make, uh, investment decisions, like building new factories or buying equipment. So, as those interest rates fall, well, that investment spending goes up. Okay, So, as what we see here is the chain effect of those prices decreasing. And with the lower prices, households are able to save a little more money. And when there's more savings available, that interest rates fall, leading to higher investment spending, Right? So, we're seeing the same chain effect in both of these. So, the wealth effect showed us that prices fell, and consumption went up, right? Um, as prices fell, we were able to consume more goods. And this is the same thing as well as prices fall here. Investment is going up, right? So lower, lower prices means higher demand here. Right? So, remember these are the components of our aggregate demand, the consumption, the investment. Now, the government spending, we're gonna leave constant for now. We're gonna leave that out for now, we'll discuss that in in chapters about fiscal policy when we deal more with the government, but we can leave it out for now. But the last piece of the puzzle, the net exports. So how is that affected by the price level? So let's think about the prices decreasing again. So what we're gonna expect, just like in the other cases as the price goes down, we're gonna see net exports go up, right? So remember that consumption, investment, government spending and net exports, those are all the parts of aggregate demand. So if those are going up that means aggregate demand, there's more demand, right? More quantity demanded. Just like we saw on our graph, okay, so let's see how this affects uh price levels affect net exports here. So if we see prices decrease and this is us prices if there's remember because now we're dealing with foreigners as well. So if the U. S. Prices are decreasing, that means us goods are cheaper. So the foreign demand for the U. S. Goods is gonna go up, right? So if the foreign people want to buy the U. S. Goods, well we're gonna export those goods right? The exports are gonna go up meaning net exports go up, right? Net exports go up, the more we export the more net exports we have. Cool. So that's how in all of these cases, what we see is lower prices leads to higher demand. And that's exactly what we see on our graph, if we go up back to our graph, let's say we're at this point right here with this price level, let's say the price level here is 1 12, right? Because this is like the C. P. I. Index meaning it's 112% of what it was in the base here, where the base here is 100. So right there is 100 and 12. And let's say there's I don't know, 16 trillion, let's just say 16 trillion in GDP at that point. And then at a lower price level, notice if we bring it down here to a lower price, let's say 108. Now, I'm just making up numbers here, this isn't necessarily how it works, but this is um this is just to make the point here on the graph, right? 16 trillion there. And as we go to a lower price level, Well, we're at a higher real GDP here, right? There's more demanded there. And that this number down here isn't just a number of goods, it's not like oh 100 bushels of corn are demanded. No, this is 16.5 trillion worth of goods, right, are demanded by the entire economy. So you can think of this as a dollar amount representing a quantity of goods. Okay, so we're still thinking about this, this access being a quantity and this access being a price just like we did in our um market demand. But now we're extending it to the whole economy where we're thinking of G. D. P. Everything produced rather than um just of one product and the price level of all the prices in the economy rather than just one price. Okay. But overall this should look very similar to what we studied in the market demand. Cool. Alright. Let's pause here and move on to the next.