The Aggregate-Demand Curve

Why the Aggregate-Demand Curve Might Shift

The downward slope of the aggregate-demand curve Opens in new window shows that a fall in the price level raises the overall quantity of goods and services Opens in new window demanded.

Many other factors, however, affect the quantity of goods and services demanded at a given price level.

When one of these other factors changes, the quantity of goods and services demanded at every price level changes and the aggregate-demand curve shifts.

Let’s consider some examples of events that shift aggregate demand. We can categorize them according to the component of spending that is most directly affected.

Shifts Arising from Changes in Consumption

Suppose Americans suddenly become more concerned about saving for retirement and, and as a result, reduce their current consumption. Because the quantity of goods and services demanded at any price level is lower, the aggregate-demand curve shifts to the left.

Conversely, imagine that a stock market boom makes people wealthier and less concerned about saving. The resulting increase in consumer spending means a greater quantity of goods and services demanded at any given price level, so the aggregate-demand curve shifts to the right. Thus, any event that changes how much people want to consume at a given price level shifts the aggregate-demand curve Opens in new window.

One policy variable that has this effect is the level of taxation.

When the government cuts taxes, it encourages people to spend more, so the aggregate-demand curve shifts to the right. When the government raises taxes, people cut back on their spending and the aggregate-demand curve shifts to the left.

Shifts Arising from Changes in Investment

Any event that changes how much firms want to invest at a given price level also shifts the aggregate-demand curve. For instance, imagine that the computer industry introduces a faster line of computers and many firms decide to invest in new computer systems.

Because the quantity of goods and services demanded at any price level is higher, the aggregate-demand curve shifts to the right. Conversely, if firms become pessimistic about future business conditions, they may cut back on investment spending, shifting the aggregate-demand curve to the left.

Tax policy can also influence aggregate demand through investment. For example,

Another policy variable that can influence investment and aggregate demand is the money supply Opens in new window. An increase in the money supply lowers the interest rate in the short run.

This decrease in the interest rate makes borrowing less costly, which stimulates investment spending and thereby shifts the aggregate-demand curve to the right. Conversely, a decrease in the money supply raises the interest rate, discourages investment spending, and thereby shifts the aggregate-demand curve to the left.

Many economists believe that throughout U.S. history, changes in monetary policy Opens in new window have been an important source of shifts in aggregate demand.

Shifts Arising from Changes in Government Purchases

The most direct way that policy makers shift the aggregate-demand curve is through government purchases. For example, suppose Congress decides to reduce purchases of new weapons systems.

Because the quantity of goods and services demanded at any price level is lower, the aggregate-demand curve shits to the left. Conversely, if state government start building more highways, the result is a greater quantity of goods and services demanded at any price level, so the aggregate-demand curve shifts to the right.

Shifts Arising from Changes in Net Exports

Any event that changes net exports for a given price level also shifts aggregate demand. For instance, when Europe experiences a recession Opens in new window, it buys fewer goods from the United States.

This reduces U.S. net exports at every price level and shifts the aggregate-demand curve for the U.S. economy to the left. When Europe recovers from its recession, it starts buying U.S. goods again and the aggregate-demand curve shifts to the right.

Net exports can also change because international speculators cause movements in the exchange rate. Suppose, for instance, that these speculators lose confidence in foreign economies and want to move some of their wealth into the U.S. economy. In doing so, they bid up the value of the U.S. dollar in the foreign exchange market.

This appreciation of the dollar makes U.S. goods more expensive compared to foreign goods, which depresses net exports and shifts the aggregate-demand curve to the left. Conversely, speculation that causes a depreciation of the dollar stimulates net exports and shifts the aggregate-demand curve to the right.

Basically, these are some idea about why the aggregate-demand curve slopes downward and what kinds of events and policies can shift this curve.