Definition: A curve that shows the negative relationship (downward slopping) 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.
How to derive it?
0 Real GDP (trillions of RM) 0 140 Aggregate expenditure (trillions of dollars ) Real GDP (trillions of RM) 45° (a) Income-expenditure model (b) Aggregate demand curve
In panel (a), the AE function intersects the 45 degree line at point e to yield RM12 trillion in real GDP demanded
Panel b shows that when the price level is 130, real GDP demanded is RM12 trillion and we have one point on the aggregate demand curve, e
Price level Deriving AD Curve e AE ( P = 130) e 130 12.0 12.0
0 Real GDP (trillions of RM) Aggregate expenditure (trillions of dollars) AE' (P = 140) e' 11.5 AE (P = 130) e 12.0 AE" (P = 120) e" 12.5 45°
If the price level increases to 140, the increase in the price level reduces consumption, planned investment, and net exports as shown by the downward shift of the aggregate expenditure line from AE to AE ' and real GDP demanded declines from RM12 trillion to RM11.5 trillion
If the price level falls, the opposite occurs: consumption, investment, and net exports increase at each real GDP
The AE function shifts to AE ': real GDP increases to RM12.5 trillion
Connecting these three equilibrium points yields the AD curve
(a) Income-expenditure model 0 140 AD e' 11.5 e 130 12.0 Real GDP (trillions of RM) 120 e" 12.5 Price level ( b) Aggregate demand curve
The inverse relationship between the price level and the quantity demanded of Real GDP is established through changes in the value of monetary wealth or money holdings based on the purchasing power of the person.
The inverse relationship between the price level and the quantity demanded of Real GDP is established through foreign sector spending, which includes local spending on foreign goods (import) and foreign spending on domestic goods (export).
When the price level for domestic goods falls, the domestic goods become relatively cheaper than foreign goods. As a result, the foreigners will buy more domestic goods. Thus, the demanded quantity of (local) Real GDP rises.
Price level rises.
When the price level for domestic goods rises, the domestic goods become relatively more expensive than foreign goods. As a result, the foreigners will buy fewer domestic goods. Thus, the demanded quantity of (local) Real GDP falls.
An increase/ decrease in the quantity of money supplied (M S ) at a given price level shifts the aggregate demand curve to the right/ left.
Any changes in autonomous component of AE Factors That Shift the Aggregate Demand Curve (Government Policy) Expansionary monetary policy M s AD curve shifts to the right Contractionary monetary policy M s AD curve shifts to the left Expansionary fiscal policy G AD curve shifts to the right Contractionary fiscal policy G AD curve shifts to the left T AD curve shifts to the right T AD curve shifts to the left
When the economy is operating at low levels of output , an increase in aggregate demand is likely to result in an increase in output with little or no increase in the overall price level (e.g. from A to B).
At low levels of aggregate output, the AS curve is fairly flat.
If an economy is damaged by war or natural disaster, the AS curve will shift to the left.
Whenever part of the resource base of an economy is reduced or destroyed, AS curve shift to the left.
Aggregate Output Price Level 0 Aggregate demand 3. . . . and the price level to rise. 2. . . . causes output to fall . . . 1. An adverse shift in the short- run aggregate-supply curve . . . Short-run aggregate supply, AS Y A P AS 2 B Y 2 P 2