Aggregate Demand


  • Gross Domestic Product – Because the aggregate demand curve is an economy’s GDP, it would make sense that a change in GDP would shift the curve. This could be a change in consumption, investment, net exports, and/or government spending. When the GDP of an economy increases, the AD curve shifts to the right.
  • Savings – When consumers decide to save more money, they have less money to spend on goods. Consequently, sales of goods and services decrease as people choose to hold money for a later time. An increase in savings leads to a decrease in consumption and investment and causes the AD curve to shift to the left.
  • Interest rates – As seen with the Loanable Funds Market, changes in interest rates directly affect the investment of an economy. When the interest rates in an economy decrease, more consumers, firms, and businesses take out loans to buy big things. This leads to an increase in investment and an overall increase in the economy’s GDP. Thus, when interest rates decrease in an economy, the aggregate demand curve shifts to the right.
  • Consumer confidence – When consumers lose faith in their economy, they often choose to save more money or spend it in other markets. This leads to a decrease in consumption in the domestic market and a consequential decrease in GDP. The aggregate demand curve thus shifts to the left.

 

Long Run Aggregate Supply

In order for an economy’s LRAS curve to shift, the economy must grow or contract. Recall that economic growth is also described in the Production Possibilities Curve. The determinants that shift the PP Curve are the same determinants that shift the LRAS. These determinants are the following:

  • Size of the Labor Force
  • Quantity/Quality of Capital
  • Quantity/Quality of Resources
  • Technology
  • Health
  • Education

An increase in any of the determinants listed above will lead to an increase in the LRAS of an economy.

Short Run Aggregate Supply

When the long run aggregate supply in an economy shifts, the short run aggregate supply shifts in the same direction. Therefore, any determinant that shifts the LRAS curve also shifts the SRAS curve in the same direction. Furthermore, the following determinants also shift the SRAS curve:

  • Business costs – As we saw in the basic supply and demand graphs, business costs directly affect supply. When costs of production increase, businesses cut back on production and supply less. Thus, when business costs increase, short run aggregate supply decreases and shifts to the left.
  • Business taxes – Similar to business costs, business taxes directly affect supply. When taxes increase, businesses lose revenue and profit less from sales. Businesses will choose to supply less when taxes are high in order to save supply for later times when profit can be higher. Thus, an increase in business taxes leads to a decrease in short run aggregate supply.
  • Business regulations – Regulations cause businesses to move and produce at slower rates as there become more “hoops” to jump through. More government requirements must be satisfied and production is slowed down. An increase in business regulations leads to a decrease in production and the short run aggregate supply curve.

 

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