Question

Derive the AD fn from the AE fn and explain the differences/similarities between the two.

Answer 1

The answer of the following question is given below as follows ;

Before starting the main question let's discuss about the Aggregate demand and the aggregate demand curve as follows:.

Aggregate demand is an economization of the demand for the total quantity of all finished goods and services produced in an economy. Gross demand is expressed as the total money exchanged for those goods and services at a specified price and time level. In macroeconomics, the focus is on the supply and demand for all goods and services produced by an economy. Consequently, the demand for all individual goods and services is also combined and is called aggregate demand.

Aggregate demand curve :The gross demand curve represents the total quantity of all goods (and services) demanded by the economy at different price levels. Below is a graphical representation of the aggregate demand curve.

Some Reason for a downward sloping aggregate demand curve as follows :

Wealth effect: The aggregate demand curve is drawn under the assumption that the government keeps the money supply constant. The money supply can be thought of as representing the wealth of the economy at any given time. As the price level increases, the wealth of the economy, measured by the supply of money, decreases in value because the purchasing power of money decreases. As buyers get poorer, they reduce their purchases of all goods and services. On the other hand, as the price level falls, the purchasing power of money increases. Buyers get richer and can buy more goods and services than before.

Interest rate effect: As the price level increases, households and businesses require more money to handle their transactions. However, the money supply is fixed. Increasing demand for a fixed supply of money causes the price of money, the interest rate, to rise. As the interest rate increases, the expense that is sensitive to the interest rate will decrease. Therefore, the interest rate effect provides another reason for the inverse relationship between the price level and the demand for real GDP.

Effect of net exports: As the domestic price level increases, foreign-made goods become relatively cheaper, so the demand for imports increases. However, the increase in the domestic price level also means that domestically made products are relatively more expensive for foreign buyers, thus the demand for exports decreases. When exports decrease and imports increase, net exports (exports - imports) decrease. Since net exports are a component of real GDP, the demand for real GDP decreases as net exports decrease.

ADDED EXPENDITURE

Aggregate Expenditure (AE) is the total desired or planned expenditure on goods and services in the economy, that is: AE = C + I + G + NX. Using the spending approach, we have seen that GDP was equal to: Y = C + I + G + NX. GDP is equal to real spending on domestically produced goods and services. Therefore, real spending on domestically produced goods and services equals income (Y) since GDP equals income of course. The aggregate spending function indicates the desired spending level at each income level (Y).

The aggregate expenditure function is an increasing function of Y. Therefore, there must be a level of income where the desired aggregate expenditure (EA) equals the actual aggregate expenditure (GDP = Y). This income level in which Y = AE is the equilibrium level of production or income (Y *)  At Y * the goods market is in equilibrium. If Y ≠ AE, then the economy is not in equilibrium. If Y> AE  excess supply in the goods market. If Y

Aggregate spending and aggregate demand are macroeconomic concepts that estimate two variants of the same value: national income.

In the subspecialty considered national income accounting, the market value of all products and services is added to estimate gross national income, the aggregate wealth produced by the country.

Both aggregate spending and aggregate demand take consumption, investment, government outlays, and net factor income from abroad as basic components of economic demand. When the economy is in equilibrium, the levels of consumer spending, investment, government outlays, and net factor income from abroad equal the total effective demand and, therefore, the value of all goods and services supplied by the economy.

Although both AE and AD are calculated by the sum of the same variable- spending expenditure, government expenditure, investment expenditure and net exports, there are some basic differences is given below as follows :

I) AE shows the relationship between total spending in the economy (dependent on income) and the level of real GDP that keeps the price level constant. Of all the components of AE, consumption expenditure is the only one that depends on income. So, a change in income causes a movement along the AE curve.

II) AD shows the relationship between price and real GDP levels, keeping everything else, including income constant. So, there is a movement along the curve when the price level changes.

POINTS TO BE REMEMBERED :

When the price level changes, there is a movement along the AD curve but there is a left or right shift in the AE curve

So When the income level changes, there is a movement along the AE curve but a left or right shift in the AD curve.

AD is the demand for all goods and services in the market at different price levels (or other curve shifters). Similarly, AE is the total expenditure in a market. But this time, we can use the definition to calculate it GDP. AD, how much demand people have in market demands (or buying goods) and services. On the other hand, how much does AE actually cost.

We can use the total expenditure model to obtain more information in the overall expenditure curve. In this section we will see how to derive the aggregate demand curve from the aggregate expenditure model. We will also see how to apply the analysis of multiplier effects in the aggregate expenditure model to the aggregate demand – aggregate supply model.

A total spending curve assumes a fixed price level. If the price level were to change, consumption levels, investment, and net exports would all change, leading to a new total expenditure curve and a new equilibrium solution in the total expenditure model.

Panel (a) "Aggregate Expenditure to Aggregate Demand" shows three possible total expenditure curves for three different price levels. For example, the total spending expenditure curve called AEP = 1.0 is the total spending curve for an economy with a price level of 1.0. Since the aggregate spending curve crosses the 45-degree line of $ 6,000 billion, the equilibrium real GDP at that price level is $ 6,000 billion. At the lower price level, the total expenditure will increase due to wealth effect, interest rate effect and international trade effect. Suppose that at every level of real GDP, a decrease in the price level of 0.5 would increase the total expenditure from $ 2,000 billion to AEP = 0.5, and an increase in the price level from 1.0 to 1.5 would increase the total expenditure to $ 2,000 billion. Will decrease. The total expenditure curve for the price level of 1.5 is shown as AEP = 1.5. There is a different aggregate spending curve for each of these three price levels, and the equilibrium is a different level of real GDP. A price level of 1.5 produces equilibrium at point A, a price level of 1.0 does so at point B, and a price level of 0.5 does so at point C. Typically, the equilibrium will have a different level of real GDP for each price. Level; The higher the price level, the lower the equilibrium price of real GDP.

This is Because of the reason that there is a different aggregate spending curve for each price level, real GDP has a different balance for each price level. Panel (a) shows the total expenditure curves for the three different price levels. Panel (b) shows that the aggregate demand curve, which reflects the quantity of goods and services sought at each price level, can thus be derived from the total expenditure model. Overall the curve for the price level of 1.0 incurs, for example, the 45-degree line in panel (A) at point B, producing an actual equilibrium of $ 6,000 billion. Thus we can plot point B B on the overall demand curve in panel (b), indicating that at the price level of 1.0, there is a real GDP demand of $ 6,000 billion.

Panel (b) shows "Aggregate demand from aggregate demand" shows how aggregate demand curves can be derived from aggregate expenditure curves for different price levels. In the aggregate expenditure model, equilibrium real GDP associated with each price level is plotted as a point reflecting the price level and quantity of goods and services demanded (measured as real GDP). At a price level of 1.0, for example, the equilibrium level of real GDP in the total expenditure model in panel (a) is $ 6,000 billion at point b. This means that there is a demand for goods and services worth $ 6,000 billion; Point B on the aggregate demand curve in panel (b) corresponds to real GDP with a demand of $ 6,000 billion and a price level of 1.0. The demand for equilibrium GDP at the price level of 0.5 is $ 10,000 billion at point C ', and the actual GDP demand level at equilibrium level of 1.5 is $ 2,000 billion at point A.' Thus the aggregate demand curve shows the equilibrium real GDP from the total expenditure model at each price level.

The lowest price level, P1, corresponds to the highest AE curve, AEP = P1, as shown. This indicates a downward sloping aggregate demand curve. The points A, B and C on the AEcurve correspond to the points A ′, B ′, and C AD on the AD curve, respectively.