Chapter 8 Aggregate Demand and Aggregate Supply

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5. Why the Aggregate-Demand Curve Might Shift

Besides the price level, many other factors affect the total quantity of goods and services demanded.

Since changes in aggregate demand could result from changes in consumption, investment, government purchases, and net exports.

If any event changes directly any of these four components of GDP (other than a change in the price level), the aggregate-demand curve will shift.

Note that a change in the price level (P) won't shift the AD curve, but will cause a movement along the AD curve.  

a. Shifts Arising from Changes in Consumption

(1) When a stock market boom makes people wealthier, people tend to consume more, aggregate demand will increase.

(2)If people become more concerned with saving for retirement and reduce current consumption, aggregate demand will decline.

(3) If the government cuts taxes, it encourages people to spend more, resulting in an increase in aggregate demand.

The resulting increase in consumer spending means a greater quantity of goods and services demanded at any given price level, so the AD curve shifts to right.

Conversely, a decrease in consumer spending results in the AD curve shifts to left.

b. Shifts Arising from Changes in Investment.

(4)Suppose that the computer industry introduces a faster line of computers and many firms decide to invest in new computer systems. This will lead to an increase in aggregate demand.

(5)If firms become pessimistic about future business conditions, they may cut back on investment spending, shifting aggregate demand to the left..

(6) When the government institutes an investment tax credit, many firms will invest in more structures, equipment, buildings, thus investment spending increases, which results in an increase in aggregate demand. 

(7) When the Fed uses an expansionary monetary policy, an increase in money supply will decrease the federal funds rate, thus other short-term interest rates would decrease as well.  This leads to more investment spending. 

An increase in investment spending indicates an increase in the quantity of goods and services demanded at any given price level, shifting the AD curve to right.

While, a decrease in investment spending will shift the AD curve to left.

c. Shifts Arising from Changes in Government Purchases

(8) If the government decides to build more highways, government spending increases and then aggregate demand increases, AD curve will shift to the right.

(9) If the government decides to reduce purchases of new weapon systems,  government spending decreases and then aggregate demand will fall, shifting the AD curve to left.

An increase in government  purchase shifts the AD curve to right; while, a decrease in government purchases shifts the AD curve to left.

d. Shifts Arising from Changes in Net Exports

(10) When Europe experiences a recession, it buys fewer American goods, which lowers U.S. net exports at every price level. Aggregate demand will shift to the left.

(11) When International investors move their wealth into the U.S. economy, they first buy dollars in foreign exchange market, resulting in appreciation of dollars. An appreciation of U.S. dollar will make U.S. goods become more expensive to foreigners and make foreign goods cheaper to U.S. residents. Thus, U.S. net exports fall and aggregate demand shifts to the left.

An increase in net exports shifts the AD curve to right; while, a decrease in net exports shifts the AD curve to left.