Aggregate Demand And Aggregate Supply Model Essay

806 Words May 13th, 2016 4 Pages
Aggregate demand and aggregate supply model is considering about the economy as a whole and used to explain how national income is determined. (economicsonline, 2016) Aggregate demand is the total demand for the economy scarce resources at a given price level and in a given period of time. It includes export(I), government spending(G), investment(X), some of consumer spending and less imports from aboard(M). The formula is AD= C+I+G+X-M. (economicsonline, 2016) Apart from imports, AD is related with price, so, C, I G and X are have different elasticity with the general level of prices. As shown below, in the short run, if price level decrease, GDP will expand, if price level increase, GDP will contract. The reasons lead to aggregate demand slopes down are the wealth effect, the interest rate effect and the exchange rate effect. The wealth effect is when all other things equal, assume the price level gone down, with the same amount of money, consumers can buy more products, so they will feel wealthier and spend more. The other one related to interest rate, at a lower price level, household can buy same products with less money, so, their savings increase which means that the supply of leaders or money lending goes up, the interest rate will go down and stimulates investment. It would cause the economy to expand and firms’ output increase. The third justification is foreign exchange rate. As interest go down, people will switch the currency to other countries, this stimulates…

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