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# What causes the aggregate demand curve to shift? The determinants of aggregate demand

## Key Questions

❶If government were to cut spending to reduce a budget deficit, the aggregate demand curve would shift to the left. This post goes over the economics of PPF construction and opportunity cost calculations, for more info on the theories behind this check

## Aggregate Demand (AD) Curve

If the Japanese Yen were to appreciate relative to the dollar, net exports would rise and the AD curve would shift to the right. Return to the course in I-Learn and complete the activity that corresponds with this material. Aggregate Supply AS is a curve showing the level of real domestic output available at each possible price level.

Typically AS is depicted with an unusual looking graph like the one shown below. There is a specific reason for why the AS has this peculiar shape. The various ranges depict three different states in which the economy may find itself.

The three states of the economy can all be thought of in relation to what is called the full-employment level of output, labeled Qf in the graph below. We will now discuss each of the three ranges of the AS. In the Keynesian range of AS, we are at outputs which are substantially below Qf. This horizontal range implies an economy in severe recession or depression. Remember that Keynes wrote his General Theory during the heights of the Great Depression, so the range of AS that is associated with his name corresponds to such an economy.

Assume that you were running a factory during a severe recession with high unemployment, and you decided that you would like to increase output. You realize that, to increase output, you are going to have to employ more inputs, primarily more labor—however, a similar argument could be made about high unemployment of any of the other factors of production. You go to the factory door, open it, and find thousands of unemployed workers standing in line, wanting to work at your factory.

How much would you have to pay them to get them to go to work for you? Certainly, you would not have to pay them more than the going wage rate in the market, right? Essentially, you could hire as many unemployed resources as you would like without bidding up wages and prices, because of the substantial unemployment. The horizontal or Keynesian AS illustrates the idea of the economy being able to increase real output with no increase in the price level during periods of high unemployment.

In the Classical Range of AS, we are at or very near the full-employment level of output. This range is named after the Classical Economists who assumed that the economy, in the long run, would always achieve full employment. Assume again that you are running a factory, only this time, the economy is at full-employment. You go to the factory door and open it to find nobody waiting in line.

There does not appear to be anyone looking for a job because everyone already has one! How much are you going to have to pay these workers to get them to do that? Most likely you will have to pay them more than they are currently making. 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. Legislators can come out in support of "their" programs, while simultaneously being against "other" programs, even though they actually voted for the "other" programs by voting for "their" programs, but they didn't really want to vote for the "other" programs and only voted for the "other" programs to ensure passage of "their" programs.

An alternative type of logrolling is explicit logrolling. Clicking the pound sign " " will generate a list of every term beginning with a number. Two out, two on, the bottom of the ninth, the home team down by a run, and Harold "Hair Doo" Dueterman -- the Primadonnas' star center fielder -- up to bat. Unfortunately Hair Doo hit the ball directly at the Primadonnas' runner on first. A line shot to the head. The runner was out. 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.

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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.

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## Main Topics

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

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The ceteris paribus factors, that is, the aggregate demand determinants, are assumed to remain constant with the construction of the curve. 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.