Aggregate Demand and Supply: Shifting Factors
Definition
Aggregate Demand (AD) is the total quantity of goods and services demanded across all levels of an economy at a given overall price level and in a given period. Aggregate Supply (AS) is the total quantity of goods and services that producers in an economy are willing and able to supply at a given overall price level.
Shifts in these curves occur when factors other than the price level change.
Factors That Shift Aggregate Demand
- Consumer Spending: Changes in consumer confidence, taxes, or wealth.
- Investment Spending: Changes in interest rates, business expectations, or technology.
- Government Spending: Fiscal policy changes (increased/decreased government expenditure).
- Net Exports: Changes in foreign income or exchange rates.
- Input Prices: Changes in wages, raw materials, or energy costs.
- Productivity: Technological advancements or improved education.
- Government Policy: Taxes, regulations, or subsidies.
Mathematically:
$$
AD = C + I + G + (X - M)
$$
where $C$ is consumption, $I$ is investment, $G$ is government spending, $X$ is exports, and $M$ is imports.
Factors That Shift Aggregate Supply
Worked Example
Suppose the government increases its spending by $100 billion. How does this affect aggregate demand?
Step 1: Recognize the component affected: $G$ increases.
Step 2: The aggregate demand equation becomes:
$$
AD_{\text{new}} = C + I + (G + 100) + (X - M)
$$
Step 3: The increase in $G$ shifts the AD curve to the right by more than $100 billion due to the multiplier effect:
$$
Delta AD = \frac{1}{1 - MPC} \times Delta G
$$
where $MPC$ is the marginal propensity to consume.
Takeaways
- Aggregate demand shifts due to changes in consumption, investment, government spending, or net exports.
- Aggregate supply shifts due to changes in input prices, productivity, or government policy.
- Policy actions and external shocks can move these curves, affecting output and prices in the economy.