Determinants of aggregate demand

Determinants of aggregate demand

1. Changes in consumer spending

   • Changes in consumer confidence
     • If consumers expect their incomes to increase, they are likely to spend more on buying goods and services, and AD shifts to the right.
     • If consumers expect their incomes to fall and economic conditions to worsen, then spending decreases, and AD shifts to the left.
     • Governments regularly measure consumer confidence by using questionnaires to try to predict the level of consumer spending.
   • Changes in interest rates
     • An increase in interest rates makes borrowing more expensive, which results in lower consumption spending, leading to a leftward shift in AD.
     • A fall in interest rates makes borrowing less expensive and results in more consumer spending, and so AD shifts to the right.
     • Interest rates can change as a result of monetary policy.
   • Changes in wealth
     • Increases in wealth means consumers are wealthier (eg. increase in stock m market values or the price of their home) so spend more, and AD shifts rightward.
     • A decrease in wealth lowers AD, so shifts to the left
   • Changes in the level of household indebtedness
     • If consumers have high debt, they are under pressure to pay monthly instalments so are likely to reduce expenditures which means AD shifts to the left.
     • A low level of indebtedness increases consumption spending and shifts the AD curve rightward.
   • Changes in personal income taxes
     • If personal income taxes increase, then consumer disposable income falls so spending drops and AD shifts to the left.
     • If personal income taxes lower, disposable income rises so AD shifts to the right.
     • Changes in tax result from fiscal policy.

2. Changes in foreigners spending

   • Changes in national income abroad
     • If country B's national income increases, it will import more goods from country A so country A's exports will increase with their AD curve shifting the right.
     • If country B's national income falls is will buy less from country A, so country A's AD shifts to the left.
   • Changes in the level of trade protection
     • Two countries may trade freely, however if country B decides to impose restrictions on imports then country A's exports fall and its AD shifts to the right.
     • However, country B reduces imports so its AD shifts to the left.
   • Changes in exchange rates
     • If country A's price of currency rises, it becomes more expensive relative to country B's currency which means country B finds country A's output more expensive thus imports less from country A, whose exports fall so AD shifts to the left.
     • However, country A finds country B's output cheaper so increase its exports from country B, and their AD increase.
     • If country A's currency decreases then exports increase whilst imports decrease so AD shifts to the right.

3. Changes in investment spending

   • Changes in business confidence
     • If business are optimistic, they spend more on investment so the AD curve shifts to the right.
     • Business pessimism results in a leftward shift in the AD curve.
   • Changes in technology
     • Improvements in technology stimulate investment spending which increases AD and shifts to the right.
   • Changes in institution
     • Increasing access to credit and securing property rights results in increases in investment spending, shifting AD to the right
   • Changes in interest rates
     • Increases in interest rates raise the cost of borrowing and force business to reduce investment spending financed by borrowing, so shifts the AD to the left.
     • Decreases in interest rates means businesses can finance their investment spending by borrowing at a lower cost, so AD shifts to the right.
   • Changes in business taxes
     • If the government increases taxes on profits of business, after tax profit falls so investment spending decreases and AD shifts to the left.
     • Decrease in taxes on profits means AD increases and shifts to the right.
   • Changes in the level of corporate indebtedness
     • If businesses have high levels of debt due to having borrowed a lot in the past, they will be less inclined to make investments so AD shifts to the left.
     • Low levels of debt leads to more investment thus AD shifts to the right.

4. Changes in government spending

   • Changes in economic priorities
     • Increased Government spending shifts the AD curve rightward.
     • Decreased Government spending shifts the AD curve leftward.
   • Changes in political priorities
     • Decreased Government spending shifts the AD curve leftward.
     • Increased Government spending shifts the AD curve rightward.
     • Governments may choose to spend on subsidies, pensions, merit goods, public goods etc which changes depending on their .