Economics Micro & Macro (CliffsAP)

■ The Interest-Rate Effect:A higher price level increases the demand for money. This rise in demand for money in-

creases interest rates, which can be thought of as the price of money. When interest rates rise, firms are less likely

to buy capital, consumers are less likely to borrow or consume, and the economy as a whole has less consumption.

Conversely, as prices fall, interest rates drop because the demand for money falls.

■ The Foreign-Purchases Effect:When the U.S. price level rises in comparison to foreign price levels, foreigners

buy fewer U.S. products and Americans buy more foreign goods. This causes U.S. exports to fall and imports to

rise. When the price level rises, it reduces the quantity of U.S. goods demanded.

Determinants of Aggregate Demand

When aggregate demand increases, the curve shifts to the right. When aggregate demand decreases, the curve shifts to
the left. Figure 4-3 illustrates an increase and decrease in aggregate demand.

Figure 4-3

Let’s take a look at the factors affecting aggregate demand: consumer spending, investment spending, government
spending, and exports.

Consumer Spending

Even when the price level of goods and services is stable, U.S. consumers may choose to consume more. When con-
sumers decide to purchase more, the aggregate demand curve shifts to the right. Some of the factors that alter consumer
spending habits are:

■ Wealth:Stocks, bonds, and physical assets are all considered consumer wealth. A sudden increase in any of these

physical or financial assets allows producers to consume more, thereby increasing aggregate demand as a result

of the wealth effect. Conversely, a major decrease in consumer wealth lowers aggregate demand.

■ Consumer expectations:Changes in consumer expectations affect aggregate demand. For example, if Joe is

expecting his annual Christmas bonus, in anticipation of receiving his bonus he will consume more goods. This

effect increases the current consumption for goods and increases aggregate demand.

■ Household debt:If households experience higher debt than normal, consumers may be forced to cut current

spending to pay off the amassed debt. If this occurs, consumption declines and the aggregate demand curve shifts

to the left.

■ Taxes:When personal income taxes decrease, consumers have more disposable income to use for goods and ser-

vices. This shifts the aggregate demand curve to the right. Tax hikes shift the curve to the left.

Price

Level

Increase In AD

Decrease In AD

Real GDP

AD^1

AD^2

AD^3

Part II: Macroeconomics