Page 214 - Krugmans Economics for AP Text Book_Neat

What you will learn
in this Module:

• How the aggregate demand Module 17
curve illustrates the
relationship between the
aggregate price level and the Aggregate Demand:
quantity of aggregate output
demanded in the economy
• How the wealth effect and Introduction and
interest rate effect explain the
aggregate demand curve’s
negative slope
• What factors can shift the Determinants
aggregate demand curve

Aggregate Demand

The Great Depression, the great majority of economists agree, was the result of a mas-
sive negative demand shock. What does that mean? When economists talk about a fall
in the demand for a particular good or service, they’re referring to a leftward shift of the
demand curve. Similarly, when economists talk about a negative demand shock to the
economy as a whole, they’re referring to a leftward shift of the aggregate demand
curve, a curve that shows the relationship between the aggregate price level and the
quantity of aggregate output demanded by households, firms, the government, and the
rest of the world.
Figure 17.1 shows what the aggregate demand curve may have looked like in 1933, at
the end of the 1929–1933 recession. The horizontal axis shows the total quantity of do-
mestic goods and services demanded, measured in 2005 dollars. We use real GDP to
measure aggregate output and will often use the two terms interchangeably. The verti-
cal axis shows the aggregate price level, measured by the GDP deflator. With these vari-
ables on the axes, we can draw a curve, AD, showing how much aggregate output would
have been demanded at any given aggregate price level. Since AD is meant to illustrate
aggregate demand in 1933, one point on the curve corresponds to actual data for 1933,
when the aggregate price level was 7.9 and the total quantity of domestic final goods
and services purchased was $716 billion in 2005 dollars.
As drawn in Figure 17.1, the aggregate demand curve is downward sloping, indicat-
ing a negative relationship between the aggregate price level and the quantity of aggre-
The aggregate demand curve shows the
relationship between the aggregate price gate output demanded. A higher aggregate price level, other things equal, reduces the
level and the quantity of aggregate output quantity of aggregate output demanded; a lower aggregate price level, other things
demanded by households, businesses, the equal, increases the quantity of aggregate output demanded. According to Figure 17.1,
government, and the rest of the world. if the price level in 1933 had been 5.0 instead of 7.9, the total quantity of domestic final

172 section 4 National Income and Price Determination