Why The Aggregatedemand Curve Might Shift

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

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

Shifts Arising from Consumption Suppose Americans suddenly become more concerned about saving for retirement 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 feel wealthy 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. 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 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. As we saw in Chapter 25, an investment tax credit (a tax rebate tied to a firm's investment spending) increases the quantity of investment goods that firms demand at any given interest rate. It therefore shifts the aggregate-demand curve to the right. The repeal of an investment tax credit reduces investment and shifts the aggregate-demand curve to the left.

Another policy variable that can influence investment and aggregate demand is the money supply. As we discuss more fully in the next chapter, an increase in the money supply lowers the interest rate in the short run. This 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 have been an important source of shifts in aggregate demand.

Shifts Arising from Government Purchases The most direct way that policymakers 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 shifts to the left. Conversely, if state governments 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 Net Exports Any event that changes net exports for a given price level also shifts aggregate demand. For instance, when Europe experiences a recession, it buys fewer goods from the United States. This reduces U.S. net exports 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, shifting the aggregate-demand curve to the right.

Net exports sometimes change because of movements in the exchange rate. Suppose, for instance, that international speculators bid up the value of the U.S. dollar in the market for foreign-currency exchange. This appreciation of the dollar would make U.S. goods more expensive compared to foreign goods, which would depress net exports and shift the aggregate-demand curve to the left. Conversely, a depreciation of the dollar stimulates net exports and shifts the aggregate-demand curve to the right.

Summary In the next chapter we analyze the aggregate-demand curve in more detail. There we examine more precisely how the tools of monetary and fiscal policy can shift aggregate demand and whether policymakers should use these tools for that purpose. At this point, however, you should have some idea about why the aggregate-demand curve slopes downward and what kinds of events and policies can shift this curve. Table 31-1 summarizes what we have learned so far.

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