AP_Krugman_Textbook

What you will learn

in this Module:

172 section 4 National Income and Price Determination

• How the aggregate demand
  curve illustrates the
  relationship between the
  aggregate price level and the
  quantity of aggregate output
  demanded in the economy


• How the wealth effect and
  interest rate effect explain the
  aggregate demand curve’s
  negative slope


• What factors can shift the
  aggregate demand curve

Module 17

Aggregate Demand:

Introduction and

Determinants

Aggregate Demand

The Great Depression, the great majority of economists agree, was the result of a mas-

sive negative demand shock. What does that mean? When economists talk about a fall

in the demand for a particular good or service, they’re referring to a leftward shift of the

demand curve. Similarly, when economists talk about a negative demand shock to the

economy as a whole, they’re referring to a leftward shift of the aggregate demand

curve,a curve that shows the relationship between the aggregate price level and the

quantity of aggregate output demanded by households, firms, the government, and the

rest of the world.

Figure 17.1 shows what the aggregate demand curve may have looked like in 1933, at

the end of the 1929–1933 recession. The horizontal axis shows the total quantity of do-

mestic goods and services demanded, measured in 2005 dollars. We use real GDP to

measure aggregate output and will often use the two terms interchangeably. The verti-

cal axis shows the aggregate price level, measured by the GDP deflator. With these vari-

ables on the axes, we can draw a curve, AD,showing how much aggregate output would

have been demanded at any given aggregate price level. Since ADis meant to illustrate

aggregate demand in 1933, one point on the curve corresponds to actual data for 1933,

when the aggregate price level was 7.9 and the total quantity of domestic final goods

and services purchased was $716 billion in 2005 dollars.

As drawn in Figure 17.1, the aggregate demand curve is downward sloping, indicat-

ing a negative relationship between the aggregate price level and the quantity of aggre-

gate output demanded. A higher aggregate price level, other things equal, reduces the

quantity of aggregate output demanded; a lower aggregate price level, other things

equal, increases the quantity of aggregate output demanded. According to Figure 17.1,

if the price level in 1933 had been 5.0 instead of 7.9, the total quantity of domestic final

Theaggregate demand curveshows the
relationship between the aggregate price
level and the quantity of aggregate output
demanded by households, businesses, the
government, and the rest of the world.