IB Economics 3.2.1 Aggregate Demand Notes

Aggregate Demand: The Total Planned Spending in an Economy

1. Aggregate demand (AD) is the total planned spending on an economy's domestic output at each price level over a period, ceteris paribus.
   1. It adds up what consumers, firms, governments, and foreign buyers plan to spend on real output, in four components.
   2. Consumer spending ($C$): all spending by households on final goods and services in a period.
   3. Investment ($I$): spending by firms and households on new capital, such as factories, machinery, offices, and newly built housing.
   4. Government spending ($G$): spending by the government on the economy, such as roads, hospitals, and public services.
   5. Net exports ($X - M$): exports minus imports.
      1. Exports are produced at home, so they count toward domestic output, while imports are spending on foreign output, so you subtract them.
2. Adding the four components gives the formula for aggregate demand.
3. $$ AD = C + I + G + (X - M) $$

Why the Aggregate Demand Curve Slopes Downward

1. The aggregate demand curve plots the price level on the vertical axis against real output on the horizontal axis.
   1. It slopes downward, so a higher price level goes with a lower quantity of real output demanded, and a lower price level with a higher quantity.

1. Three effects explain why buyers demand more real output when the price level falls.
   1. Wealth effect: a lower price level raises the purchasing power of the money and savings people hold, so households feel wealthier and buy more.
   2. Interest-rate effect: a lower price level lowers interest rates, so firms borrow more cheaply to invest and households save less and spend more.
   3. International-trade effect: a lower domestic price level makes home-produced goods cheaper than foreign ones, so exports rise and imports fall, raising net exports.
2. All three describe a movement along the AD curve as the price level changes, not a shift of the whole curve.