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Aggregate Demand and Supply
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Aggregate Demand (AD)
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Aggregate Demand
· The sum of all expenditure in the economy
over a period of time
· Macro concept ­ WHOLE economy
· Formula:
AD = C+I+G+(X-M)
­ C= Consumption Spending
­ I = Investment Spending
­ G = Government Spending
­ (X-M) = difference between spending on
imports and receipts from exports (Balance
of Payments)
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Aggregate Demand Curve
· Shows the overall level of spending at
different price levels
· Note ­ Inflation used for the vertical
axis ­ follows from new thinking on the
derivation of AD curves from the likes of
David Romer @ University of California
­ Assumes Central Banks do not target
the money supply but short term
interest rates
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Aggregate Demand Curve
· Why does it slope down from left to right?
­ Assume Bank of England sets short term
interest rates
­ Assume a rise in the price level will be met
by a rise in interest rates
­ Any increase in interest rates will raise the
cost of borrowing:
· Consumption spending will fall
· Investment will fall
· International competitiveness will decrease ­
exports fall, imports rise
· Therefore ­ a rise in the price level leads to
lower levels of aggregate demand
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