AP_Krugman_Textbook

module 17 Aggregate Demand: Introduction and Determinants 173

goods and services demanded would have been $950 billion in 2005 dollars instead of
$716 billion.
The first key question about the aggregate demand curve involves its negative slope.

Why Is the Aggregate Demand Curve Downward

Sloping?

In Figure 17.1, the curve ADslopes downward. Why? Recall the basic equation of na-
tional income accounting:

(17-1) GDP=C+I+G+X−IM

whereCis consumer spending, Iis investment spending, Gis government purchases of
goods and services, Xis exports to other countries, and IMis imports. If we measure
these variables in constant dollars—that is, in prices of a base year—then C+I+G+
X−IMrepresents the quantity of domestically produced final goods and services de-
manded during a given period. Gis decided by the government, but the other variables
are private -sector decisions. To understand why the aggregate demand curve slopes
downward, we need to understand why a rise in the aggregate price level reduces C, I,
andX−IM.
You might think that the downward slope of the aggregate demand curve is a natural
consequence of the law of demand. That is, since the demand curve for any one good is
downward sloping, isn’t it natural that the demand curve for aggregate output is also
downward sloping? This turns out, however, to be a misleading parallel. The demand
curve for any individual good shows how the quantity demanded depends on the price
of that good, holding the prices of other goods and services constant. The main reason the quan-
tity of a good demanded falls when the price of that good rises—that is, the quantity of a
good demanded falls as we move up the demand curve—is that people switch their con-
sumption to other goods and services that have become relatively less expensive.
But when we consider movements up or down the aggregate demand curve, we’re con-
sideringa simultaneous change in the prices of all final goods and services.Furthermore, changes

figure 17.1

The Aggregate

Demand Curve

The aggregate demand curve shows

the relationship between the aggregate

price level and the quantity of aggre-

gate output demanded. The curve is

downward sloping due to the wealth

effect of a change in the aggregate

price level and the interest rate effect

of a change in the aggregate price

level. Corresponding to the actual 1933

data, here the total quantity of goods

and services demanded at an aggre-

gate price level of 7.9 is $716 billion in

2005 dollars. According to our hypo-

thetical curve, however, if the aggre-

gate price level had been only 5.0, the

quantity of aggregate output demanded

would have risen to $950 billion.

5.0

7.9

Aggregate price

level (GDP deflator,

2005 = 100)

Aggregate demand

curve, AD

1933

A movement down the

AD curve leads to a lower

aggregate price level and

higher aggregate output.

0 950 $716 Real GDP

(billions of

2005 dollars)