Deriving Aggregate Demand from the AE Model

Alright. So we can use our aggregate expenditure model to derive the aggregate demand curve. Let's see how they go hand in hand. So, recall about the aggregate expenditures model, right? The aggregate expenditures, this is the spending in the economy, right? So you can imagine that demand and spending are very interrelated. So aggregate expenditures model can be used to derive the aggregate demand curve. So the big difference between these curves is where price level, how price levels affect the curves. So when we think about the aggregate expenditures curve, Well, the aggregate expenditures model remember on this axis we had aggregate expenditures, so the the amount of spending in the economy and remember that's equal to consumption plus investment plus government spending plus net exports. Right? The spending in the economy, compared to GDP what we were calling the production in the economy. Right? And we're looking for an equilibrium between the production and the spending in the economy. Right. But nowhere on this graph do we show price levels, what is the price level in the economy? But price level determines these these factors. Right? Just like we've been discussing, the level of consumption is determined by price level, investment by the price level. And we talked about net exports also being affected by the price level. But when we move to the aggregate demand graph, we do have price level on the graph, right? Just like we saw when we first discussed aggregate demand, we saw price level um on the graph, right, we had the price level, in the level of GDP on the graph. So let's go ahead and let's model some different aggregate expenditures. And let's see how that can relate to our aggregate demand curve. We're gonna draw below. So if you recall we would have some level of aggregate expenditures and we'll we'll start here and say there's some sort of medium price in the economy. And at this medium price we would have, so we'll say this is aggregate expenditures, one right here and this is with a medium price, some some medium level of price. And we're gonna see what happens when the price goes up and when the price goes down. Right? So we would have an equal economic equilibrium macroeconomic equilibrium right here at this level of aggregate expenditures which would be equal to this level of production. So we'll say this is G. D. P. One right here, the first level of GDP. And now let's discuss two other aggregate expenditures. So what would happen if there were higher prices in the economy if there were higher prices? Do you think this aggregate expenditures would go up or down in this case? So let's think about higher prices. If prices are higher, there's gonna be less consumption, less investment, less net exports. Right at these higher prices, all of these things are going to fall, there's gonna be less consumption because of the wealth effect, less investment because of the interest rate effect. Less net exports because of the exchange rate effect. Right? We're going to see all of these things being affected by by the price level. So what are we gonna see happening here at a higher price? We would have lower aggregate expenditures because all of those pieces of the puzzle would be smaller. We would have less of all of them. So we'll say this is a E. Two at a high price. Right? So at this higher price. So this is an H. Right here at a higher price. Well what are we gonna have and we'll call this one here GDP medium. Uh Just just to keep the same pneumonic there and here we go uh at this higher price. Well look what's happened to our equilibrium, our equilibrium is much much lower, right? We have a much lower GDP over here which is at the high price, we have a a lower equilibrium G. D. P. So less production happens at these higher prices. And then what about the other situation? What if we had low prices, what low prices? Well that's the opposite, right? There's gonna be more consumption going on, more investment and more net exports. So we would have um some sort of curve up here and you can kind of see what's following here, we're gonna have some higher level of GDP. So at this this low prices we've got this high level of GDP, right? GDP right there and this will be aggregate expenditures three when the prices are low. Right? So where the only thing we're changing here is the price level in the economy and then we're seeing how that affects the aggregate expenditures curve. So now that we've got our three levels of GDP there let's see how that affects our aggregate demand curve. So let's build an aggregate demand curve based on those three levels of G. D. P. So I'm gonna go down to this graph and remember this is the price level. So the prices in the economy and this is G. D. P. Down here, right? The quantity of G. D. P. That's gonna be demanded. So how much production are we demanding based on these different price levels? So in the first case let's go to the first case where we had a medium price, right? We had a medium price and we had this medium amount of GDP right right in the middle. So what do we have? We'll start right here and say this is price level medium. So maybe that will be you know we'll just put some numbers to it. We'll say this is like a price level of 106 compared to the base here. So at this price medium we'll put a point right here for the medium amount of G. D. P. So we're just estimating these here. So GDP medium. And then what happens when we raise the price level? So at the high price level notice on this graph when we have the high price level, the high price level we've got less GDP, right less GDP happening at the lower, Excuse me at the higher prices there's less GDP. So that's what we're gonna see here. If we go and put a higher price so we'll put a price high over here say 1 12. Well at that price of 1 12 there's less GDP demanded. So we'll draw a point over here to represent the lower GDP. So notice there's a higher amount of price but a lower amount of G. D. P. And this is the G. D. P. At the high price. And then finally We've got our third point that we we graft was a low price. So now there's lower prices in the economy, we'll put something down here for price low and we'll say that's equal to like 102 compared to the base here. And if we go out just like we saw on our graph when we had the low prices that shifted the aggregate expenditures upward, there was more expenditures leading to this higher level of G. D. P. So with the low prices we've got more GDP. And what do we have here? So if we if we put this on the graph right here representing the lower prices, well now we've got our aggregate demand curve right based on the different price levels how much of this G. D. P. Is demanded which is going to be this line right here right based on the different price levels, we've got different amounts of GDP demanded and that is our aggregate demand curve. Right? So that's how we can derive the aggregate demand curve from the aggregate expenditures model based on what the different what the different equilibrium G. D. P. S are based on different price levels. Okay, so we just did a bunch of estimation, but the the the principle stays the same that as price level increases, I'll do price level increases. Well, that means aggregate expenditures decrease right. Price levels increasing. Aggregate expenditures are decreasing, right? Because each of those C plus I plus G plus N X. Right? We're seeing this decrease, we see this decrease. So all of those decreasing leads to a lower level of aggregate expenditures as those prices are higher. Cool. Alright, so that's how we derive the aggregate demand curve. Let's discuss another thing about these two graphs on the next

So now let's say we're holding price levels constant. We were seeing how price levels affected uh the the aggregate expenditure model leading us to be able to derive that aggregate demand curve. But now let's say that the price level is constant, but there's a change in one of the determinants of aggregate expenditure. And when I say determinants of aggregate expenditure, we're talking still about C plus I plus G plus N. X. Right? Let's say there's some big boost in investment spending, right? Investment spending increases uh investment spending increases leading to an overall increase in aggregate expenditures. Right? So this is what we saw with the multiplier effect. But just in general, if investment goes up well, we're going to see aggregate expenditures go up. Right? So this has nothing to do with the price level. But let's see what this does to the aggregate demand curve. So let's say this is our original aggregate demand, aggregate expenditures curve right here. A. E. One and we're holding price constant, price is constant, Right? So there's no change in price happening, but there is an increase in investment spending, right? Some sort of increase in investment spending, let's say maybe um there's some expectation about future profitability, right? So businesses want to invest more. So in that case we are going to have to shift the A. E. Curve up by the amount of investment spending. Right? So we would shift it up for the extra investment spending leading to a new aggregate expenditure curve out here 82. But remember price is still constant, it's still the same price levels but there's just been more investment spending in this situation. So what do we see? We're gonna have this original equilibrium G. D. P. So remember this is a E. Over here, G. D. P. On this axis. So we have this this equilibrium G. D. P G. D. P. One um before we have that increase in spending and then there's this new equilibrium GDP out here after the investment spending that is higher, right? Just like we expect there's some higher level of equilibrium GDP with the higher aggregate expenditures. So there we go now that we see this what how does this relate to our aggregate demand curve? Well, what's happening is remember we're holding price levels constant here. So price is gonna stay here, the price level. So this is the price level on this side of the graph and we've got G. D. P. On this side of the graph. And what did we have? We had our aggregate demand curve, right, that looks something like this. And at this price level we could say that this was G. D. P. One right here. In the first situation, the aggregate expenditures one, This was G. d. p. one right here on the graph. But what's happened is the price level hasn't changed but there's a new demand, a new amount of G D. P demanded here, Right? So it could be something like out here we have a new point for GDP to so in this case this is gonna look similar to what we did with market demands as well is what's happening is the price is being held constant. But something else is shifting our aggregate demand curve and that's a change in investment spending. Right? So as investment spending goes up well our aggregate demand curve shifts to the right, right? Because we're keeping the price level constant the same level of prices. But there's more GDP demanded at that price. And that's because of that increase in the investment spending leading to an increase in the G. D. P. At that price level. Right? So there's not only can price shift this graph upwards. Other things can shift it as well such as the level of investment spending. And when the level of investment spending goes up. Well we have a shift in our aggregate demand curve. Right? So that's how the aggregate expenditures model that we've learned previously correlates with this model of the aggregate demand and aggregate supply together. Alright. So knowing that let's go ahead and move on to the next video