Updated Jun 26, 2020 Aggregate demand (AD) describes the total amount of goods and services buyers are willing and able to purchase within a particular market. In most cases, a fall in the price level increases the overall quantity of goods and services demanded (which is why the aggregate demand curve slopes down). However, other factors affect AD. Aggregate demand can be calculated as the sum of consumer spending (C), investment spending (I), government spending (G), and net export (X – M). Whenever one of those components changes, the curve shifts. Thus, in the following paragraphs, we will take a closer look at each component and the factors that cause shifts in aggregate demand. Any event that changes how much people want to consume at a given price level shifts the aggregate demand curve. More specifically, any development in a market that leads people to spend more money on consumption causes the aggregate demand curve to shift to the right and vice versa. The most common policy variable used by the government to affect the level of consumption is taxation. For example, imagine the government cuts income taxes. This makes people wealthier, which encourages them to spend more money. As a result, the aggregate demand curve shifts to the right. Conversely, a negative economic outlook (e.g., a looming recession) may lead people to become more concerned about saving their money rather than spending it. This leads to a fall in consumer spending, which causes the aggregate demand curve to shift to the left. Any event that changes how much firms want to invest at a given price level also shifts aggregate demand. That means any event that results in higher investment spending at the current price level causes aggregate demand to shift to the right and vice versa. Policymakers can influence the level of investment through taxation or the money supply. To illustrate this, let’s say the government introduces an investment tax credit. That means it introduces a tax deduction on business investments, which ultimately reduces the cost of investments. As a result, companies are incentivized to invest more, and the aggregate demand curve shifts to the right. Meanwhile, if the central bank restricts the money supply, interest rates rise (in the short run), and borrowing money for investing becomes more expensive. As a result, firms reduce investment spending and aggregate demand shifts to the left. Any event that changes government purchases at a given price level also shifts the aggregate demand curve. That is, whenever the government decides to reduce purchases, the aggregate demand curve shifts to the left and vice versa. Thus, government purchases are the most direct way that policymakers can use to affect AD. For example, assume the government decides to build more roads to reduce traffic jams. This results in a higher demand for goods and services related to public and private transport, which causes the aggregate demand curve to shift right. Conversely, if the government decides to cut back on military spending, the demand for armaments and weapon systems decreases, and AD shifts to the left. Any event that changes net exports for a given price level also shifts aggregate demand. That means any change in the economy that increases the difference between exports and imports causes aggregate demand to shift to the right and vice versa. The most common policies and factors that affect net exports are trade tariffs imposed by the government or changes in exchange rates (see also nominal and real exchange rates). To illustrate this, let’s say the government decides to impose import tariffs on dairy products to protect local farmers. This reduces imports and thereby increases net exports. As a result, the local aggregate demand curve shifts to the right. Meanwhile, an appreciation of the US dollar makes exports relatively more expensive. Therefore, fewer foreign firms buy US products, net exports fall, and aggregate demand shifts to the left. Aggregate demand (AD) describes the total amount of goods and services buyers are willing and able to purchase within a particular market. It can be calculated as the sum of consumer spending (C), investment spending (I), government spending (G), and net export (X – M). Whenever one of those components increases, the curve shifts to the right and vice versa.1. Shifts Arising from Consumption (C)
2. Shifts Arising from Investment (I)
3. Shifts Arising from Government Purchases (G)
4. Shifts Arising from Net Exports (X – M)
Summary
Macroeconomics