In this video we will examine the factors that cause aggregate demand to increase and
shift right, or decrease and shift left.
Aggregate demand will shift rightwards towards AD2 when increasing and leftwards towards
AD1 when decreasing.
I’ve draw the curves red and green to correspond to the following information on aggregate
demand curve shifts.
Next we will examine the factors that would cause consumption to rise and fall.
These will be the factors that influence consumer spending throughout an economy.
We will look at the factors that cause consumption to increase first.
When consumers have positive expectations and high confidence about the future, they
are more likely to spend in the present.
The understanding behind this is that they have a positive outlook on the future.
They may believe their job is secure, opportunity is available and businesses are performing
well.
Their friends may be finding work relatively easily and many indicators point to continued
prosperity.
On the other hand, if their outlook is bleak and they feel that the economy is experiencing
a downturn, their confidence levels drop and expectations become more pessimistic.
They are more careful with spending and are more inclined to save or pay off debt.
To understand why, you should put yourself in the shoes of someone who has just seen
their colleagues get laid off.
If this person returns home and turns on the news to hear news of doom and gloom in the
economy, their confidence is likely to drop and they will take careful measures to protect
themselves in the case that the downturn hits them next.
Next, if the value of asset such as a home starts to rise in value, people may feel wealthier
and start to increase their spending.
If other assets, such as the value of stocks and bonds in one’s investments rise in value,
then this could also lead to greater spending.
Conversely, if the stock market crashes or house prices plummet like we saw in the 2008-2009
Recession, then people are less likely to spend and more likely to save in fear of what
may come next for their job or household.
If government reduces income or sales taxes, it will either result in people having greater
disposable income or paying lower prices for goods and services.
As a result, aggregate demand will increase.
To counter that, an increase in personal income tax or sales taxes will reduce disposable
income or increase the sale price of goods and services.
Prior to the 2008 crisis, there was a rapid growth of credit available which led to many
people getting mortgages that could not afford them.
By securing home loans quite easily, consumers were quick to purchase homes at a rapid rate.
This drove up home prices and eventually led to the inevitable crash.
Soon after the recession hit, credit became much harder to secure.
Borrowing to buy a home is now much stricter in comparison to pre-crisis.
As a result, consumption is reduced and aggregate demand falls.
If interest rates are higher it is also generally more expensive to borrow and more rewarding
to save.
As a result, consumption will fall.
If interest rates are lower, it is cheaper to borrow and less rewarding to save and therefore
consumption will rise.
Next we’ll examine the factors that influence business spending throughout an economy.
Remember, we’re looking at the overall level of spending throughout the entire economy
and not just focusing on a specific sector.
Similar to consumption, a reduction of the interest rate will result in cheaper borrowing
and a greater likelihood to pursue investment projects.
Conversely, increasing the interest rate will result in less borrowing and a reduced likelihood
of pursuing investment projects.
If business confidence is high and firms have a positive outlook about the economic future,
then they are more likely to invest.
They will ramp up production in anticipation.
On the other side of this, if firms have a negative outlook about the future, they will
likely reduce investment.
This could involve reducing production and cutting the workforce.
Thirdly, if the government enacts corporate tax cuts, businesses face lower production
costs and are able to retain greater profit.
They are then more likely to increase production and raise output.
If the government decides to raise corporation tax, they are increasing the cost of doing
business.
This will likely result in a reduction of output and a fall in production.
Thirdly, we’ll examine government spending.
Generally government spending is influenced by the overall performance of the economy,
but there are other times when they may choose to spend.
Let’s see what they are.
Government spending falls under fiscal policy.
When the government is pursuing expansionary fiscal policy they will increase spending
and reduce taxes.
Specifically for government spending as a component of aggregate demand we focus on
expenditure.
There are many areas of government expenditure including government services, war and infrastructure
projects.
We’ll explore the categories of government spending further in the video on fiscal policy.
For now, what you should understand is that an increase in government spending will result
in an increase in aggregate demand, and vice versa.
Part of our future analysis will consider the impact of government spending on economic
growth.
Finally, net exports.
We have to see the factors that would increase or decrease the value of net exports.
These factors can impact either the amount a country buys from or sells to the rest of
the world.
Net exports are calculated by subtracting imports from exports.
For net exports to increase, there would need to be an increase in exports or a fall in
imports, ceteris paribus.
If the domestic currency depreciates, then it takes less foreign currency to purchase
our domestic currency.
Here’s an example to clarify, using China as the domestic country.
If the Chinese RMB depreciates against the dollar, that means it now takes more RMB to
buy US dollars, making American imports more expensive.
That also means that the US dollar now buys more RMB.
This means it takes less dollars to buy Chinese exports, which will lead to an increase in
exports for China, increasing the Chinese aggregate demand.
The opposite also holds true.
When the domestic currency appreciates, it takes more foreign currency to purchase our
domestic currency.
Therefore, for similar reasons as mentioned just before, our exports will fall and our
imports of foreign goods will rise.
Secondly, when incomes abroad increase the market for our exports grows larger.
If the rest of the world gets richer, they are more likely to buy a country’s exports.
This can be seen in the rising Chinese demand for luxury goods from around the world.
The Chinese purchases of Italian cars will increase the aggregate demand for Italy.
However, when incomes abroad are falling, aggregate demand can fall.
Chinese exports fell during 2008-2009 in large part due to the global recession.
This reduced the value of net exports and thus real GDP for the Chinese economy.
Also, by increasing the competitiveness of their goods and services, a country can increase
their net exports.
Whether through price or quality, by making goods more attractive in the global market,
they are more likely to be exported.
That’s an extensive look at the factors that cause aggregate demand to shift and it’s
important that you get some practice in doing so.
Some students consider the aggregate demand curve easier to come to grips with than aggregate
supply, which we will be examining in a later video.
As for now, get as much practice as you can with aggregate demand shifts.
If you have any questions or comments, please leave a message below or email me at enhancetuition@gmail.com.
You can also tweet me @enhancetuition.
I’ll include a link in the video notes for the slideshare presentation.