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lecture 25 ~ chapter 14 (15).docx

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Hannah Holmes

How do aggregate demand and aggregate supply differ from demand and supply? Aggregate demand curve  Y = A . F (K,LH,N) tells us who’s buying the stuff we’re making  Y = C + I + G + NX how we combine inputs to produce the outputs  AD: Y = C + I + G + NX (everything we produce, taking net exports production in other countries)  The AD curve has a negative slope for three reasons: 1. Wealth effect 2. Interest rate effect 3. Real exchange rate effect  Demand curve: Substitute goods; ad: already including everything, what can you sub 1. Wealth Effect  Price goes down  people feel wealthier  they shop more  consumption spending goes up  Y ^ = C^ + I + G + NX 2. Interest rate effect  (ch 15) 2 financial assets: money (doesn’t pay interest), bonds (do pay interest) o holding money is expensive, giving up the money you could be earning on a bond : opportunity ccost o opportunity cost of holding money = interest rate  price levels go down but people don’t want to buy more stuff, want to buy the same amount of stuff they were buying o if buying the same quantity and the prices are now lower  don’t need as much money (money demand curve shifts left, int rate goes down) o when interest rate goes down, investment goes up so Y goes up 3. Real exchange rate effect  price goes down, (eP/P*) real exchange rate goes down  canadian goods become less expensive  we import less (sub away from expensive foreign goods)  exports increase, more people want canadas products  NX ^
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