ECO 201: Chapter 4

Chapter 4: Aggregate Demand and Aggregate Supply


1. Aggregate Demand (AD)

●​ Definition: The total quantity of goods and services demanded across all levels of the
economy at various price levels, during a specific period.​


Shape of AD Curve:

●​ Downward sloping – due to:​

1.​ Wealth Effect: As price levels fall, real wealth increases → more consumption.​

2.​ Interest Rate Effect: Lower price levels → lower interest rates → more
investment.​

3.​ Net Export Effect: Lower domestic prices → exports become cheaper → net
exports increase.




2. Components of Aggregate Demand

Formula:​
AD = C + I + G + (X - M)

●​ C (Consumption): Spending by households​

●​ I (Investment): Spending by businesses on capital goods​

●​ G (Government Spending): On goods and services (not transfer payments)​

●​ X (Exports) – M (Imports): Net exports​

, 3. Shifts in Aggregate Demand

AD shifts when any of the components (C, I, G, X-M) change for reasons other than price
level.

Increase in AD (Shift Right):

●​ Rise in consumer confidence/income​

●​ Increase in investment due to optimism or lower interest rates​

●​ Higher government spending​

●​ Increase in exports (due to exchange rates or foreign growth)​


Decrease in AD (Shift Left):

●​ Fall in consumer/business confidence​

●​ Higher interest rates​

●​ Lower government spending or increased taxes​

●​ Drop in net exports​




4. Aggregate Supply (AS)

●​ Definition: The total quantity of goods and services that producers in an economy are
willing and able to supply at various price levels.​