What causes the aggregate demand curve to shift to the right or the left?
Anything that effects consumption, investment, government spending, or the foreign market (exports and imports).
What causes consumer spending to change?
What causes business spending to change?
What causes government spending to change?
What causes exports and imports to change?
Of the factors listed above which are controlled by the government?
Consumption
What is consumption?
Consumption occurs whenever consumers purchase goods or services. Consumption is measured by the amount of money spent by all consumers. When you buy lunch, that is consumption.
What are some factors that impact how much consumption there is in the U.S. economy?
Without question the most important contributor to consumption is a person’s level of income and potential income in the future.
Present income is the amount a person earns now.
Future or permanent income is the expected earnings over a lifetime.
Another factor that impacts the amount a person earns is his/her family income. Families make spending decisions together.
Interest rates also affect consumption. Low interest rates inspire spending.
Confidence in the economy and employment enables consumption.
Tax rates directly affect that amount of money available for consumption. When personal taxes increase, disposable income decreases causing consumption to fall.
Savings preferences impact consumption. Increases in savings decreases consumption. Some societies are more prone to save than others. Some age groups are more apt to save than others.
Intertemporal decisions impact today’s consumption as well.
Life Cycle Hypothesis.
Investment
What is investment?
An increase in business investment will lead to an increase in aggregate demand. When the aggregate demand curve increases the GPD increases, the unemployment rate falls, and inflation rises.
What are the factors that effect investment?
interest rates (-)
corporate profits (+)
expectations of future demand for the product (?)
expansion opportunities (+)
According to Keynes how can the government control investment?
increase the money supply, interest rates decrease, investment rises
According to Keynes, the way the government can change investment is to change the money supply. The government (through the agency of the Federal Reserve Bank) can increase or decrease the money supply. An increase in the money supply gives the banks more money to lend. Typically when banks have more money to lend they will lower their interest rates. When they lower their interest rates businesses are more likely to borrow money to start new projects, or to finance new equipment. The amount of investment rises, and the aggregate demand curve shifts to the right. Then, the GDP rises, inflation rises and the unemployment rate falls. In summary, if the government (Federal Reserve Bank) wants to stimulate the economy they will increase the money supply. The downfall of increasing the money supply is that inflation rises.
Is this a very direct approach to influencing the aggregate demand curve?
- No, an increase in the supply of money must cause interest rates to fall banks must lower interest rates
- banks must be willing to lend money
- businesses must be willing to borrow money
- consumers must be willing to buy the goods, businesses are producing
What sectors of the economy are sensitive to interest rate changes?
A summary of the graphical process, an increase in the money supply causes interest rates to decrease. When interest rates decrease, investment rises. When investment rises the aggregate demand curve shifts right. GDP increases, unemployment falls, inflation rises.
Government Spending
according to Keynes if the government increases spending, gdp will increase by the amount of government spending times the multiplier.
ie if the multiplier is 3, if the government increases their spending by $1000 then gdp will rise by $3000.
The multiplier can be measured in two ways
1. the change in gross domestic product/ the change in government spending
multiplier = 3000/1000 = 3
What are the downfalls of government spending
higher deficits
higher taxes
higher interest rates
disincentive to work
what should the government spend their money on?
Keynes summary
An increase in taxes causes a decrease in disposable income. This causes a decrease in consumption, and a decrease (shift left) of the aggregate demand curve
An increase in the money supply causes a decrease in interest rates, which causes an increase in investment. The increase in investment causes an increase in the aggregate demand curve.
An increase in government spending directly increases the aggregate demand curve.
The three government tools are taxes, money supply and government spending.
