Aggregate demand (AD) and the aggregate demand curve

Explaining aggregate demand and the aggregate demand curve

Aggregate demand(AD)
- is the total amount of real output (real GDP) that consumers, firms, the government and foreigners want to buy at each possible price level, over a particular time period.
- it includes
  - the demand of consumers (C)
  - the demand of businesses (I)
  - the demand of government (G)
  - the demand of foreigners for exports (X) minus the demand for imports (M) (X-M or net exports)
- AD shifts rightward -> AD increases -> for any price level, a larger amount of real GDP is demanded
- AD shifts leftward -> AD decreases -> for any price level, a smaller amount of real GDP is demanded
The determinants of aggregate demand (shifts in the AD curve)
- causes of changes in consumption spending
  - changes in consumer confidence
    - consumer confidence is a measure of how optimistic consumers are about their future income and the future of the economy.
    - if consumers are optimistic about the future
      - they are likely to spend more on buying goods and services, and the AD curve shifts to the right
    - low consumer confidence indicates expectations of falling incomes and worsening economic conditions, due to fears in unemployment and cut in wages
      - they are likely to spend less on buying goods and services, and the AD curve shifts to the left
  - changes in wealth
    - wealth is the value of assets (资产) that people own, such as savings in their bank accounts, houses, stocks and bonds, jewellery, works of art, and so on;
    - an increase in consumer wealth(for example an increase in the value of homes) makes people feel wealthier
      - therefore they spend more and the AD curve shifts to the right
    - a decrease in consumer wealth(for example a depreciate on housing prices) makes people feel less wealthier
      - therefore they spend less, lowers the AD, shifts it to the left
  - changes in the level of household indebtedness 债务水平的变化
    - indebtedness refers to how much money people owe from borrowing in the past.
    - if consumers have a high level of debt(such as credit card use or taking out loans), then they are under pressure to make high monthly payments to pay back their loans plus interest
      - so are likely to cut back on their present expenditures
      - lower consumtpion, lower AD, AD shifts to the left
    - a low level of indebtedness
      - increases consumption spending
      - increases AD, shifts the curve of AD rightward
  - expectations of future price levels
    - consumer spending may be influenced by what they expect prices to be in the future
    - if they expect prices of goods and services to fall, they may postpone spending as they wait for prices to fall
      - in the present, this will cause the AD to decrease and shift the curve leftward
    - if they expect future prices to increase, they may buy more now in order to avoid the higher prices later
      - in the present, the consumption spending will increase, AD will increase and shift rightward
  - changes in income taxes
    - income taxes are the taxes paid by households on their incomes
    - if the government increases income taxes, then consumer’s disposable income, which is the income leftover after personal income taxes have been paid, falls
      - therefore, consumption spending drops, and the AD curve shifts to the left
    - if personal income taxes are lowered, the result is higher disposable income
      - this leads to a rightward shift of AD, an increase in the AD
  - changes in interest rates
    - some consumer spending is financed by borrowing
    - an increase in interest rate makes borrowing more expensive
      - resulting in lower consumer spending, and AD shifts leftward
    - a fall in interest rates makes borrowing less expensive
      - results in more consumer spending and a rightward shift in the AD curve
- Causes of changes in investment spending
  - changes in business confidence
    - business confidence refers to how optimistic firms are about their future sales and economic activtiy.
    - if businesses are optimistic
      - they spend more on investment, and the AD curve shifts to the right
    - if they are not optimistic
      - they spend less on investment, and the AD decreases, shifts to the left
  - changes in interest rate
    - increases in interest rates raise the cost of borrowing, and force businesses to reduce investment spending financed by borrowing
      - therefore, AD decreases and shifts to the left
    - decreases in interest rates mean firms can now finance their investment spending by borrowing at a lower cost
      - therefore, the AD curve shifts to the left and decreases
  - changes(improvements) in technology
    - improvements in technology stimulates investment spending
      - thus causing an increase in investment, AD increases, shifts to the right
  - changes in business taxes
    - business taxes in this context refer to taxes on profit(corporate income taxes)
    - if the government increases taxes on profits of businesses, firms’ after-tax profits fall
      - investment spending decreases and the AD curve shifts to the left
    - decreases in business taxes will increase firms’ after-tax profits
      - investment spending increases, AD increases and shifts to the right
  - the level of corporate indebtedness
    - if businesses have high levels of debt due to past borrowing
      - they will be less willing and able to make investments and the AD curve shifts to the left
    - if businesses have low levels of debt, on the other hand
      - they will be more willing and able to make investments, leads to higher AD and a rightward shift
  - legal/insititutional changes
    - the legal and institutional environment in which businesses operate has an impact on investing spending
    - small businesses often do not have access to credit, meaning they cannot borrow easily to finance investments
      - investment fall, AD decreases, leftward shift
    - increasing access to credit(the ability to borrow) and secure property rights
      - this will make the firms more able and willing to make investments, investment increases, AD increases, rightward shift of the curve
- Causes of changes in government spending
  - Changes in political priorities
    - governments have many expenditures, arising from provision of merit goods and public goods, spending on subsidies and pensions, payments of wages and salaries to its employees, purchases of goods for its own use, and so on
    - it may decide to increase or decrease its expenditures in response to changes in its priorities
    - increased government spending
      - AD increases, rightward shift
    - decreased government spending
      - AD decreases, leftward shift
  - Changes in economic priorities;deliberate efforts to influence aggregate demand
    - the government can use its own spending as part of a deliberate attempt to influence AD
    - the effects of such changes in g spending on AD are the same as ‘political priorities’
- Causes of changes in export spending minus import spending
  - Changes in national income abroad（this ‘abroad’ is very important, representing international trade; since changes in national income domestically won’t cause any changes on AD)
    - country B’s national income increases, then it will import more from country A. So country A’s net exports increase
      - net exports of A increase, AD increases and shifts to the right
    - country B’s national income decreases, then it will import less from country A. So country A’s net exports decrease
      - net exports of A decrease, AD decreases and shifts to the left
  - Changes in exchange rates
    - an exchange rate is the price of one country’s currency in terms of another country’s currency
    - country A’s exchange rate increases, means its currency appreciates, becoming more expensive relative to country B; so country B will buy less from A, A’s export decreases; But at this point, consumers in A will find goods and services in B less expensive, so country A will import more from B. Net exports decrease.
      - both leads to a fall in AD and leftward shift
    - country A’s exchange rate decreases, means its currency depreciates, becoming less expensive relative to country B; so country B will buy more from A, A’s export increases; But at this point, consumers in A will find goods and services in B more expensive, so country A will import less from B. Net exports increase.
      - both leads to a rise in AD and rightward shift
  - Changes in trade policies, or the level of trade protection
    - ‘trade protection’ refers to restrictions to free international trade often imposed by governments
    - country B’s government decides to impose restrictions on imports from country A, then A’s exports will fall
      - leads to a fall in AD and leftward shift
    - in country B, restrictions on imports from country A will decrease B’s imports, B’s net exports will increase
      - leads to a rise in AD and rightward shift