Skip Nav

Determinants of aggregate demand

Recommended for you

❶Lesson 04 Section Independent of its price, anything that makes resources more productive will increase AS and shift the AS curve to the right; anything that makes resources less productive will decrease AS and shift the AS curve to the left.

Key Questions

What is 'Aggregate Demand'
BREAKING DOWN 'Aggregate Demand'

As you bid up wages in the labor market to attract additional workers, prices in the economy will also rise, because now it costs more to produce your product. That additional cost is passed to the consumer in the form of higher prices, to the extent possible. Attempts to increase output in the Classical Range leads to higher price levels in the economy but what about real GDP? Does it actually increase?

Well, your output may go up, but the output of the factory where your new workers used to work will go down, so the overall output in the economy stays the same at Qf. In the Intermediate Range, we are at output levels that are below full employment, but not so far below as to constitute a deep recession or depression.

In this range, increasing output is possible, but only at the expense of rising prices. While that Keynesian Range is a rare short-run occurrence, and the Classical Range is the long-run steady state of the economy, the Intermediate Range is probably where we find ourselves most often in the economy. Depending on the state of the economy, any attempt to change the output of the economy will move us along a given AS curve.

There are factors that influence aggregate supply, illustratable by shifting the AS curve—these factors are referred to as determinants of AS. When these other factors change, they cause a shift in the entire AS curve and are sometimes called aggregate supply shifters.

The graph below illustrates what a change in a determinant of aggregate supply will do to the position of the aggregate supply curve. As we consider each of the determinants remember that those factors that cause an increase in AS will shift the curve outward and to the right and those factors that cause a decrease in AS will shift the curve upward and to the left.

Anything that causes input prices to rise will decrease AS and shift the AS curve to the left. Anything that causes input prices to fall will increase AS and shift the AS curve to the right.

For instance, if a particular input into the production process is readily available from domestic suppliers, it will generally be cheaper, holding all else constant cet.

If for no other reason, transportation costs of delivering a domestic resource to a domestic producer will be less than delivering the identical resource from a foreign supplier. That does not even take into account the problems of getting a foreign resource such as duties and tariffs, political or social instability abroad, or other international disruptions.

Another factor that can influence input prices would be the market power of the suppliers of the resource. The more competition in the supply of a resource, the cheaper that resource will be, cet. If the resource is supplied by a monopolist or a cartel think OPEC oil , the price of that resource will be higher than if the resource is supplied by a more competitive industry think corn-produced ethanol.

Independent of its price, anything that makes resources more productive will increase AS and shift the AS curve to the right; anything that makes resources less productive will decrease AS and shift the AS curve to the left. If workers become more productive because of investments in physical or human capital, the economy will be able to produce more and the AS curve will shift to the right. If workers become less productive because of outmoded equipment, insufficient training, or excessive union interference in their workplace, the economy will be less productive, and the AS curve will shift to the left.

In brief, business taxes increase the cost of production and shift the AS curve to the left; subsidies decrease the cost of production and shift the AS curve to the right. Government regulations also influence the costs of production. What does the equilibrium between AD and AS determine? Equilibrium is illustrated below as the intersection between AD and AS.

Notice that in the intermediate range, there is a tradeoff between two of the key economic variables that concern US citizens: Typically, we would like both inflation and unemployment to be low. In the intermediate range, however, if we increase AD, inflation will go up as unemployment falls notice that if real GDP is going up, unemployment is going down: On the other hand, if we decrease AD, inflation will fall but unemployment will rise. There is no way to simultaneously decrease inflation and decrease unemployment using demand side shifts.

Do you think that decreases in AD have exactly the opposite effects as the increases? Why do you think that prices would go up very easily but fall only slowly? Part of the answer has to do with the fact that it actually costs businesses money to change their prices think of printing new catalogs, printing new menus, recoding prices in a computer and on scanners, or sending a worker out to change the prices on a marquee.

It is worth it to the business to incur this expense when the price is going up, but when the price is going down they are hesitant to take on the expense of changing prices! During the s, a variety of factors shifted the AS curve to the left.

The high inflation that was combined with a stagnant economy low levels of output and high unemployment gave rise to the term Stagflation.

When Ronald Reagan was elected President in , the inflation rate was Reagan employed supply side policies that were designed to shift the AS curve to the right and reduce both inflation and unemployment simultaneously. Only by supply side policies can you decrease both inflation and unemployment at the same time.

By the time that Reagan left office eight years later, the inflation rate in the economy was 4. When the AD curve intersects the AS curve in the Keynesian Range or in the Intermediate Range such that output is below Qf, there exists what is called a recessionary gap.

The gap represents the amount of government spending that would be necessary to shift the AD to the right enough to bring output to Qf. In the Keynesian Model, the magnitude of the shift in AD will depend on the size of the multiplier. For example, if the multiplier is 2. So if the AD needs to be shifted to the right by million dollars to get to Qf and the multiplier is 2.

Conversely, if the AD needs to be shifted to the left to get to Qf, there is an inflationary gap and the same multiplier principles would apply. The changes in government spending that would close an inflationary or recessionary gap are applications of fiscal policy, which is the topic of our next lesson.

Course Introduction Section Introduction to Macroeconomics Introduction to Macroeconomics Section Lesson 04 Section Economic Growth in the U. Lesson 07 Section Demand increases or decreases along the curve as prices for goods and services either increase or decrease.

Also, the curve can shift due to changes in the money supply , or increases and decreases in tax rates. Boosting aggregate demand also boosts the size of the economy regarding measured GDP. However, this does not prove that an increase in aggregate demand creates economic growth. Since GDP and aggregate demand share the same calculation, it only echoes that they increase concurrently.

The equation does not show which is the cause and which is the effect. Early economic theories hypothesized that production is the source of demand.

The 18th-century French classical liberal economist Jean-Baptiste Say stated that consumption is limited to productive capacity and that social demands are essentially limitless, a theory referred to as Say's law. Say's law ruled until the s, with the advent of the theories of British economist John Maynard Keynes. Keynes, by arguing that demand drives supply, placed total demand in the driver's seat.

Keynesian macroeconomists have since believed that stimulating aggregate demand will increase real future output. According to their demand-side theory, the total level of output in the economy is driven by the demand for goods and services and propelled by money spent on those goods and services. In other words, producers look to rising levels of spending as an indication to increase production.

Keynes considered unemployment to be a byproduct of insufficient aggregate demand because wage levels would not adjust downward fast enough to compensate for reduced spending. He believed the government could spend money and increase aggregate demand until idle economic resources, including laborers, were redeployed. Other schools of thought, notably the Austrian School and real business cycle theorists, hearken back to Say.

They stress consumption is only possible after production. If the government raises taxes, or reduces government spending, then the aggregate demand curve shifts left contractionary policy.

If the government lowers taxes, or increases government spending, we will see the AD shift right expansionary policy. Monetary policy is the result of the federal reserve at least in the United States manipulating interest rates in the economy. If the federal reserve raises interest rates, then we will see aggregate demand decrease or shift left because it has become more expensive to finance investment. Alternatively, if the federal reserve decreases interest rates, we will see investment increase, and aggregate demand will shift right.

Finally international variables can change a change in NX and here we focus on changes in GDP and the exchange rate:. If the currency in your country becomes stronger the exchange rate goes up then your exports become more expensive in other countries, so less are bought. This means exports go down, and thus net exports declines.

A decline in exports causes aggregate demand to shift left. If your currency becomes weaker, then countries are able to purchase more of your goods because they are relatively cheaper. This increases exports, and net exports, and therefore shifts aggregate demand right. Also, if GDP is rising faster in your country than others around the world, then the purchase of imports will rise. This reduces net exports and therefore shifts aggregate demand to the left. This will shift aggregate demand to the right.

Below you will find a video that goes over AD shifts with explanations showing several examples of shifts in the aggregate demand curve. Tags aggregate supply and demand macroeconomics. Best flea treatment 12 December. Newer Post Older Post Home. Ask a question search this site. Common Topics algebra 34 economics 50 glossary 25 macroeconomics 57 microeconomics supply and demand How to calculate marginal costs and benefits from total costs and benefits , and how to use that information to calculate equilibrium.

At many points in the semester you will be asked to calcula Constructing a PPF and calculating opportunity costs.

This post goes over the economics of PPF construction and opportunity cost calculations, for more info on the theories behind this check How to finish solving your comparative advantage, or gains from trade problem.

Now we have to determine who has the comparative advantage in each good. Want to contribute to freeeconhelp. Use paypal to donate to freeeconhelp.

Main Topics

Privacy Policy

The demand curve only shows the relationship between the price and quantity. If one of the other determinants changes, the entire demand curve shifts.

Privacy FAQs

Start studying Determinants of Aggregate Demand and Supply. Learn vocabulary, terms, and more with flashcards, games, and other study tools.

About Our Ads

Analogous to other determinants, aggregate demand determinants shift the aggregate demand curve. A change in any of the determinants can either increase or decrease the aggregate demand curve. An increase in aggregate demand is illustrated by a rightward shift in the aggregate demand curve. The sixth determinant that only affects aggregate demand is the number of buyers in the economy. The aggregate demand curve shows the quantity demanded at each price. It's similar to the demand curve used in microeconomics.

Cookie Info

Aggregate demand is the term used to describe any and all demand in an economy. It is not demand for any one specific good. It is the total demand in an economy. Therefore, Aggregate demand = Consumption + Investment + Government Expenditure + Net exports. So the key determinants are the demand by consumer for goods and services which drives all the 4 components of aggregate demand.