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Video transcript

in this in the next few videos we're going to be studying something called aggregate supply and aggregate demand and actually we're going to start with aggregate demand and then start talking about aggregate supply so we're going to think about aggregate demand and aggregate aggregate I'll rewrite the word aggregate aggregate supply and what I really want to emphasize in this video is in a lot of ways it's going to look similar to traditional supply and demand but I want to emphasize that there's a very big difference between aggregate demand and traditional demand in a macro in a micro economic context and aggregate supply in a macroeconomic context context and just regular supply in a microeconomics context and to think about that lets go to the micro version so this these are macroeconomics so we're looking at an economy as a whole these are macro these are macro ideas and to make that comparison let's revisit the micro the micro economics ideas of supply and demand and to do that we could focus on just a particular market maybe it's the market for candy bars so this is the market for candy bars and we've seen this many many many times this is most of what we were doing when we were studying microeconomics on the vertical axis we would we would plot the price per unit from the candy bar and in the horizontal axis you would have the quantity the quantity bought or sold in a given amount of time and we saw that the demand curve tended to be downward sloping it would look something like that and then there was multiple ways to interpret this one way to interpret this as a at a high price people would say hey why should I buy this candy bar I could buy other things with that money that would make me just as happy or happier and so they would purchase a low quantity of it and at a low price at a low price so this is a low price right over here people say hey this is a pretty good deal I can get candy bars they're so cheap I can buy a bunch of them instead of buying other things instead of buying lollipops and ice cream I'll buy candy bars and then they'll buy a high quantity of it so that's one way to interpret it the other way to interpret it was as essentially as a marginal benefit curve that very first few units of candy bars that get produced there's someone there who just loves candy bars so much there's a high willingness to pay for it there's a high benefit for those first few units but as you have more and more the incremental benefit to the market gets less and less you could view it as there are people there who just they still like candy bars but not as much as the people who bought those first few units but that is why you have a downward sloping curve now when we think about aggregate demand it's going to look very similar but the idea is a good bit different so let's draw I'll do it in a different color to show that it's different so now we're in the macro version and we're talking about aggregate demand aggregate demand and so the first thing to realize is if we talk about aggregate demand we're thinking about the economy as a whole we're not just thinking about the market for just one good or service and an aggregate demand what we do is we plot on the horizontal axis not quantity not just the quantity bought or sold of one good or service in an amount of time we plot the actual production of the economy in a given period of time and we've already studied that the actual production of the economy in a given period of time is real GDP so we plot on this axis real GDP so it's really how much are we producing and I guess there is an analogy to quantity is kind of the quantity of the productivity of the economy and in this axis right over here we plot price level so this is prices but this isn't price this isn't prices for one good or service for this isn't just a price for candy bars this is the general level of prices in the economy or you may be say you know the weighted average or however you want to measure it some way of measuring the level of prices in the economy and what we will see is that this is a downward sloping curve it does look like this it will look something like this or we can assume or at least actually we actually don't know whether it definitely looks like that but economists will tell you it looks like that based on certain theories and they like it this way because it starts to explain based on their models and you can kind of separate out the emotional aspects of economics it is one way of potentially explaining economic cycles although as you know from the last video I'm actually a stronger believer in the emotional aspects of it but it will be downward sloping it will be downward sloping like this and once again this is one product goods or service right over here this is the economy as a whole this is just the general level of prices this is the actual productivity of the economy so this is saying and it's a little unintuitive at first that if prices are high if prices are high and it's seldom this extreme it's not like the GDP would go to zero but we'll just assume it's simplified like this maybe I'll draw it something like this maybe I'll have it something like maybe draw it something like that so I don't have to make the extreme statement that if prices are at some level that there will be no GDP but it's just general saying that if prices are high GDP will contract and if all and remember ceteris paribus ceteris paribus all other things equal if prices are low GDP will expand and it's happening for completely different reasons then this downward sloping this downward sloping was essentially a substitution effect when prices are high people said hey I don't need to buy candy bars I can go buy ice cream or Slurpees or slushies or something else that makes me happy or and when prices are low they say hey let me substitute candy bars for other things because I'm getting a good deal on candy bars over here that is not what is happening what's happening here and there's a couple of kind of theories why why economists will justify a downward sloping aggregate demand curve so this right here is let me make this clear this is aggregate demand this is the demand this is this is this is essentially saying how much productivity there will be in the economy as a function of price levels in the economy so this is aggregate demand and this is just demand right over here and there's three major theories why economists believe that there is a downward sloping aggregate demand curve the first is called the wealth effect let me write these down the first is called the wealth effect wealth the first is called the wealth effect and the wealth effect is just a saying and this is once again it's a little non-intuitive because when I you know and in my mind when I start saying hey prices have gone down I start saying oh well if prices have gone down wages have gone down and maybe profits have gone down and then people will get less optimistic and then the economy will shrink but that's not what we're saying in this chart right over here remember ceteris paribus all other things equal where zooming over here only so if we pick this scenario right over here we're assuming only prices have gone down everything else in the economy is equal employment has not changed profits have not changed people's people's optimism has not changed the only thing that changes is people wake up one day and everything in the economy is half the price it was before and people have the same savings they have the same amount of what money in their wallet and if that happens all things equal now they say hey with the same amount of money that I have in my wallet I can now buy more I feel wealthier so that's the wealth effect they will say I will go and demand more goods and services because what what with what I have in my pocket I can go buy more things and likewise if for whatever reason people woke up the next morning and remember all other things equal they said everything the price of everything were to double did say oh my god I can't buy anything anymore everything's too expensive I have to buy less of it I'm going to demand fewer goods and services and so the wealth effect is one theory that would explain remember all other things equal why you would have a downward sloping aggregate aggregate demand curve the other one is related to interest rates the other one is related to and I would call it savings savings effect savings and interest rate effect interest interest rate effect because you can imagine if before if before this bar represented the total amount of money someone had in their pockets and this is how much they needed to spend on goods and services in order to have a nice happy productive life and this is what they were originally going to save now all of a sudden if things get a lot cheaper if things get a lot cheaper they don't have to spend this much on goods and services they could pretend less on goods and services so maybe if things got a lot cheaper they could spend less on goods and services so now they could spend maybe this amount on goods and services and they could save much more so right over here so if things if everyone remember at all other things equal if everyone woke up tomorrow when things were just half-price people would be able to spend less on the things they need and they would be able to save a lot more money and we've seen before savings when people save money it just goes into the financial system you save it you put it into the bank and it just gets lent out to other people and so when you when you have increase in savings so remember all other things equal when prices go down all other things equal then savings go up which means that the supply of money the supply of money to be lent supply of lenders or money to be lent money lending goes up and we saw that in a previous video if you increase the supply of money that can be let the price of borrowing the money will go down or another way to think about it interest rates interest rates will go down and when interest rates go down it becomes cheaper you have to spend less interest to borrow money and make investments you know borrow money build a house borrow money build a factory borrow money do whatever buy inventory and so interest rates go down that stimulates that stimulates investment that stimulates investment which once again would cause the economy to expand you would have more goods and services being produced and likewise if you went the other way if prices went up so this is prices this is a situation where prices went down if prices went up now all of a sudden people have to spend more of their money more on the of their money on what the things that they maybe think that they need to survive and be happy and there will be less savings and if there's less savings then there's less money to be lent and then there will be higher interest rates and then there will be less investment and so the economy will contract so real GDP and remember when I saved you to GDP here maybe I'll call it real GDP real GDP would go down so this is real real GDP would go up and then the third theory of why or the third I guess justification because economists like to have this downward sloping curve so that they can justify the when we'll see how a Gregorian demand can cause business cycles the third effect is essentially I'll call it a foreign exchange effect for an exchange effect so foreign foreign exchange based on the line of reasoning so let's say the situation once again where prices went down based on the line of reasoning in justification two we said if prices go down then interest rates interest rates go down because there's more money to be lent in that economy in that currency and if interest rates go down investors might say hey I can get I only get low interest in my country why don't I go take why don't I convert my money into other currencies where I can get higher interest rates and so if interest rates go down people convert out of the currency convert out of the currency so maybe before if we're talking about America and we're maybe the interest rates are really low in the u.s. and interest rates are higher in in the UK maybe because prices didn't go down there as much people say hey I'm going to convert my money from dollars to pound sterling and when they do that they will literal essentially because once again if people are converting from and I've gone in depth on some of the videos on foreign exchange if people are converting from dollars to pounds that means that there's a larger supply of dollars and and more demand for pounds so the price of the dollar relative to the pound will go down or essentially the dollar will weaken the dollar dollar will weaken relative to other currencies and if the dollar weakens relative to the other currencies and if this is a little confusing I go into more depth into this when I talk about currency exchange if the dollar weakens relative to other currencies then American goods and services are going to appear to be cheaper - people say in England for example if I offered to tutor let's say if I offer to make a car in America for $10,000 $10,000 before maybe $10,000 before this all of this happened translates into 5,000 pounds but now the dollar has weakened so now $10,000 is going to translate into 4,000 pounds and so foreign consumers will say hey wow American car has just got cheaper when we viewed in our own currency and so more and more of them are going to want to buy American thing so America will export more and once again if there's more demand for American goods and services the GDP will expand so this is related to interest low interest rates driving people to take currency out or exchange out of the currency we're talking about which will make that currency cheaper which will make its goods and services cheaper to the rest of the world which will essentially once again make make make net exports increase or you can really just cut to the chase and say well look if the price level all of a sudden in u.s. dollars just got cheaper people say hey there's deals to be had in the US and once again net exports would increase so once again when you have low price level you could have lar you could have GDP expanding and obviously if the prices were to increase the the opposite dynamic might occur
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