119 Shifts in Aggregate Demand
What you’ll learn to do: examine factors that shift aggregate supply and aggregate demand
In this section, you’ll learn about the macroeconomic factors that cause shifts in the aggregate supply and aggregate demand model. The readings introduce what causes shifts in the AD curve, particularly changes in the behavior of consumers or firms and changes in government tax or spending policy. We’ll also discuss two of the most important factors that can lead to shifts in the AS curve: productivity growth and changes in input prices.
Learning Objectives
- Describe the causes and implications of shifts in aggregate demand
Shifts in Aggregate Demand
Demand shocks are events that shift the aggregate demand curve. We defined the AD curve as showing the amount of total planned expenditure on domestic goods and services at any aggregate price level. As mentioned previously, the components of aggregate demand are consumption spending (C), investment spending (I), government spending (G), and spending on exports (X) minus imports (M). A shift of the AD curve to the right means that at least one of these components increased so that a greater amount of total spending would occur at every price level. This is called a positive demand shock. A shift of the AD curve to the left means that at least one of these components decreased so that a lesser amount of total spending would occur at every price level. This is called a negative demand shock. The next module on the Keynesian Perspective will discuss the components of aggregate demand and the factors that affect them in more detail. Here, the discussion will sketch two broad categories that could cause AD curves to shift: changes in the behavior of consumers or firms and changes in government tax or spending policy.
Do Imports Diminish Aggregate Demand?
We have seen that the formula for aggregate demand is AD = C + I + G + X – M, where M is the total value of exported goods. Why is there a minus sign in front of imports? Does this mean that more imports will result in a lower level of aggregate demand?
Actually, imports are already included in the formula in the form of consumption (C) or investment (I). When an American consumer or business buys a foreign product, it gets counted along with all other consumption and investment. Since the income generated does not go to American producers, but rather to producers in another country, it would be wrong to count this as part of domestic demand. Therefore, imports added in consumption or investment are subtracted back out in the M term of the equation.
Because of the way in which the demand equation is written, it is easy to make the mistake of thinking that imports are bad for the economy. Just keep in mind that every negative number in the M term has a corresponding positive number in the C or I terms, and they always cancel out.
How Changes by Consumers and Firms Can Affect AD
When consumers feel more confident about the future of the