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In this and the next few videos

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we're going to be
studying something called

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"aggregate supply" and "aggregate demand."

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Actually, we're going to start

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with aggregate demand

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and then start talking
about aggregate supply.

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We're going to think
about aggregate demand

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and aggregate, I'll rewrite the word,

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aggregate supply.

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What I really want to emphasize

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in this video is in a lot of ways,

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it's going to look similar to

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traditional supply and demand,

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but I want to emphasize that there's

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a very big difference between

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aggregate demand and traditional demand

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in a microeconomic context.

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Aggregate supply in a macroeconomic

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context and just regular supply

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in a microeconomic context.

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To think about that,

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let's go to the micro version.

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These are macroeconomics

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so we're looking at economy as a whole.

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These are macro ideas.

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To make that comparison,

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let's revisit the micro-,

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the microeconomics ideas of

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supply and demand.

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To do that, we can focus on

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a particular market.

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Maybe it's the market for candy bars,

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so this is the market for candy bars.

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We've seen this many, many, many times,

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this is most of what we were doing

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when we were studying microeconomics.

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On the vertical axis, we would

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plot the price per unit from

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the candy bar and the horizontal axis

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you would have the quantity bought or sold

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in the given amount of time.

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We saw that the demand curve

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tended to be downward sloping,

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it would look something like that.

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There was multiple ways to interpret this.

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One way to interpret this at a high price,

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people would say, "Why should I buy this

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candy bar? I could buy other things

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with that money that would make me

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just as happy or happier."

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So they would purchase
a low quantity of it.

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At a low price, this is a low price

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right over here, people say,

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"This is a pretty good deal. I can get

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candy bars, they're so cheap,

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I can buy a bunch of them.

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Instead of buying other
things, instead of buying

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lollipops and ice cream,
I'll buy candy bars,"

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then they'll buy a high quantity of it.

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So that's one way to interpret it.

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The other way to interpret it was

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as essentially as a
marginal benefit curve.

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That very first few units of candy bars

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to get produced, there's someone there

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who just loves candy bars so much

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there's a high willingness to pay for it.

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There's a high benefit
for those first few units.

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As you have more and more units,

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the incremental benefit to the market

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gets less and less.

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You can view as they are people who

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still like candy bars, but not as much

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as the people who bought
those first few units.

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That is why you have a
downward sloping curve.

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When we think about aggregate demand,

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it's going to look very similar,

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but the idea is a good bit different.

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I'll do it in a different color

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to show that it's different.

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Now we're in the macro version.

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We're talking about aggregate demand.

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Aggregate demand.

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The first thing to realize is we're

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talking about aggregate demand.

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We're going to be thinking about

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the economy as a whole.

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We're not just thinking about

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the market for just one good or service.

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In aggregate demand, what we do is

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we plot on the horizontal
axis, not quantity,

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not just the quantity bought or sold

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of one good or service
in an amount of time,

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we plot the actual production of

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the economy in a given period of time.

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We've already studied that.

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The actual production of the economy

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in a given period of time is real GDP.

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We plot, on this axis, real GDP,

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so it's really how much are we producing?

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I guess there is an analogy to quantity,

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it's kind of the quantity of the

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productivity of the economy.

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In this axis right over here,

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we plot price level.

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This is prices.

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This isn't prices for one good or service,

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this isn't just a price for candy bars,

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this is the general level of prices

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in the economy.

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Maybe you're saying
it's a weighted average

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or however you want to measure it,

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some way of measuring the level

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of prices and economy.

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What we will see is this is a

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downward sloping curve.

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It does look like this.

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It will look something like this or

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we can assume, we actually don't know

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whether it definitely looks like that,

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but economists will tell
you it looks like that

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based on certain theories.

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They like it this way because

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it starts to explain,

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based on their models,

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and you can kind of separate out

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the emotional aspects of economics,

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it is one way of potentially

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explaining economic cycles,

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although if you know from the last video

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I'm actually a stronger believer in

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the emotional aspects of it.

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But it will be downward sloping.

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It will be downward sloping like this.

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Once again, this is one product,

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goods or service right over here.

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This is the economy as a whole.

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This is just a general level of prices.

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This is the actual
productivity of the economy.

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This is saying, and it's
a little unintuitive

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at first, that if prices are high,

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it's seldom this extreme, it's not like

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the GDP would go to zero,

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but we'll just assume it's simplified

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like this ... Maybe I'll draw it with

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something like this ...

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Maybe I'll have it something like,

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maybe draw it something like that

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so I don't have to make the extreme

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statement that if prices
are at some level,

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that there will be no GDP.

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Generally saying if prices are high,

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GDP will contract and remember,

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ceteris paribus, all other things equal,

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if prices are low, GDP will expand.

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It's happening for completely different

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reasons than this downward sloping.

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This downward sloping is essentially

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a substitution effect.

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When prices are high, people say,

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"I don't need to buy candy bars.

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I can go buy ice cream or Slurpees

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or Slushees or something else

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that makes me happy," or

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and when prices are low, they say,

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"Let me substitute candy bars for

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other things because I'm getting a good

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deal on candy bars."

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Over here that is not what is happening.

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What's happening here,
and there's a couple

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of theories why economists will justify

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a downward sloping aggregate demand curve,

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let me make this clear,
this is aggregate demand.

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This is essentially saying
how much productivity

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there will be in the economy as a function

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of price levels in the economy.

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This is aggregate demand ...

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And this is just demand right over here.

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There's three major theories why

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economists believe that
there is a downward

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sloping aggregate demand curve.

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The first is called the "wealth effect."

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Let me write these down.

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The first is called the "wealth effect."

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The wealth effect is just saying,

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and once again, it's
a little nonintuitive,

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because in my mind when I start saying

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prices have gone down, I start saying,

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"Prices have gone down,

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wages have gone down, maybe

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profits have gone down, and then

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people will get less optimistic,

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the economy will shrink."

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That's not what we're saying

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in this chart right over here.

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Remember, ceteris paribus ...

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All other things equal.

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We're assuming over here only,

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so if we take this
scenario right over here,

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we're assuming only prices have gone down.

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Everything else in the economy is equal.

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Employment has not changed.

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Profits have not changed.

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People's optimism has not changed.

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The only thing that changes is

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people wake up one day and everything

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in the economy is half the price

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it was before.

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People have the same savings.

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They have the same amount of money

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in their wallet.

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If that happens, all things equal,

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now they say, "With the same amount of

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money that I have in my wallet,

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I can now buy more. I feel wealthier."

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That's the wealth effect.

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They will say, "I will go and demand more

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goods and services
because with what I have

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in my pocket, I can go buy more things."

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Likewise, if for whatever reason people

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woke up the next morning ...

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Remember, all other things equal,

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if the price of everything were to double,

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they say, "Oh my God! I can't buy anything

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anymore. Everything's too expensive.

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I have to buy less of it. I'm going to

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demand fewer goods and service."

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The wealth effect is one theory

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that would explain,
all other things equal,

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why you would have a downward sloping

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aggregate demand curve.

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The other one is related
to interest rates.

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I would call it savings
and interest rate effect.

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Interest rate effect.

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You can imagine, if before this bar

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represented the total amount of money

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someone had in their pockets,

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and this is how much they needed to spend

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on goods and services in order to have

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a nice, happy, productive life,

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this is originally what they were

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going to save, now all of a sudden,

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now if all of a sudden if things get

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a lot cheaper, they don't have to

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spend this much on goods and services.

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They could spend less

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on goods and services.

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Maybe if things got a lot cheaper,

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they could spend less
on goods and services.

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Now they could spend maybe this amount

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on goods and services,

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and they could save much more.

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Right over here ... Remember,

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all other things equal,

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if everyone woke up tomorrow

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and things were just half priced,

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people would be able to spend less

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on the things they need,

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and they would be able
to save a lot more money.

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We've seen before, savings,

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when people save money, it just goes into

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the financial system.

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You save it, you put it into the bank,

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and it just gets lent out to other people.

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So when you have increase in savings,

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all other things equal,

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when prices goes down,

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all other things equal,

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then savings go up which means

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that the supply of money to be lent,

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supply of lenders or money to be lent,

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money lending goes up.

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We saw that in a previous video.

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If you increase the supply of money

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that can be lent, the price of

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borrowing the money will go down.

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Another way to think about it,

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interest rates.

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Interest rates will go down.

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When interest rates go down,

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it becomes cheaper,

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you have to spend less interest

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to borrow money and make investments.

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Borrow money, build a house.

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Borrow money, build a factory.

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Borrow money, do whatever
... buy inventory.

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Interest rates go down,

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that stimulates investment,

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that stimulates investment,

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which once again, would cause

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the economy to expand.

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You would have more goods and services

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being produced.

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Likewise, if you went the other way,

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if prices went up,

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this is a situation
where prices went down.

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if prices went up, now all of a sudden,

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people have to spend more of their money.

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More of their money on the things

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that they maybe think that they need

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to survive and be happy.

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There will be less savings.

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If there's less savings,

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there's less money to be lent.

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There will be higher interest rates

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and there will be less investment,

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so the economy will contract.

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So real GDP ... And remember,

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when I say GDP here, maybe
I'll call it real GDP,

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real GDP would go down.

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This is real GDP would go up.

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The third theory of why ...

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or the third justification because

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economists like to have this downward

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00:10:47,509 --> 00:10:48,789
sloping curve so that they can justify,

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and we'll see how aggregate supply

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and demand can cause business cycles,

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the third effect is essentially,

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I'll call it a foreign exchange effect.

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A foreign exchange effect.

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Foreign exchange.

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Based on the line of reasoning,

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so let's say a situation once again where

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prices went down,

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based on their line of reasoning and

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justification, we said if prices go down,

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then interest rates go down because

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there's more money to be lent

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in that economy in that currency.

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If interest rates go down,

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investors might say,

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"I only get low interest in my country.

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Why don't I convert my money into

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00:11:29,305 --> 00:11:30,581
other currencies where I can get

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00:11:30,581 --> 00:11:31,938
higher interest rates?"

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00:11:31,938 --> 00:11:33,688
So if interest rates go down,

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00:11:33,688 --> 00:11:35,457
people convert out of the currency.

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Convert out of the currency.

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00:11:40,524 --> 00:11:42,190
So maybe before, if we're talking about

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America and maybe the interest rates

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00:11:44,159 --> 00:11:46,334
are really low in the
US and interest rates

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are higher in the UK, maybe because

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prices didn't go down there as much,

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people say, "I'm going to convert my money

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from dollars to pound sterling."

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When they do that, they will essentially,

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because once again, if people are

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converting from ... I've gone in-depth

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on some of the videos on foreign exchange,

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if people are converting from dollars

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00:12:05,274 --> 00:12:07,741
to pounds, that means that there's

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a larger supply of dollars and

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more demand for pounds.

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The price of the dollar relative to

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the pound will go down.

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Essentially, the dollar will weaken.

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00:12:16,737 --> 00:12:22,416
The dollar will weaken
relative to other currencies.

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If the dollar weakens relative to

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the other currency,

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this is a little confusing,

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I go into more depth into this when

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I talk about currency exchange,

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if the dollar weakens relative to

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other currencies, then American

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00:12:32,715 --> 00:12:34,731
goods and services are going to appear

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to be cheaper to people in England.

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For example, if I offer to make a car

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in America for $10,000,

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maybe $10,000 before all of this happened,

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translates into 5,000 pounds,

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but now the dollar has weakened.

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Now $10,000 is going to translate into

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00:12:56,135 --> 00:12:58,021
4,000 pounds.

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Foreign consumers will say,

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00:12:59,485 --> 00:13:01,862
"Wow, American cars just got cheaper

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00:13:01,862 --> 00:13:03,606
when we view it in our own currency."

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More and more of them are going to want

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to buy American things so America will

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00:13:06,785 --> 00:13:08,536
export more.

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00:13:08,536 --> 00:13:10,006
Once again, if there's more demand

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00:13:10,006 --> 00:13:11,362
for American goods and services,

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00:13:11,362 --> 00:13:13,211
the GDP will expand.

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00:13:13,211 --> 00:13:16,185
This is related to low interest rates

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00:13:16,185 --> 00:13:18,078
driving people to take currency out

384
00:13:18,078 --> 00:13:20,943
or exchange out of the currency we're

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00:13:20,943 --> 00:13:22,535
talking about, which will make that

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00:13:22,535 --> 00:13:23,530
currency cheaper, which will make

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00:13:23,530 --> 00:13:24,660
its goods and services cheaper to

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00:13:24,660 --> 00:13:25,922
the rest of the world,

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00:13:25,922 --> 00:13:27,315
which it will essentially

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00:13:27,315 --> 00:13:31,588
once again, make net exports increase.

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00:13:31,588 --> 00:13:32,882
You really could just cut to the chase

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00:13:32,882 --> 00:13:34,914
and say if the price level all of a sudden

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00:13:34,914 --> 00:13:36,311
in US dollars just got cheaper,

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00:13:36,311 --> 00:13:38,447
people say there's deals to be had

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00:13:38,447 --> 00:13:40,314
in the US, and once again,

396
00:13:40,314 --> 00:13:42,318
net exports would increase.

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00:13:42,318 --> 00:13:43,922
Once again, when you have low price level,

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00:13:43,922 --> 00:13:47,644
you could have GDP expanding.

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00:13:47,644 --> 00:13:48,979
Obviously if the prices were to increase,

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00:13:48,979 --> 00:13:52,066
the opposite dynamic might occur.