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Why does the Aggregate Demand curve decreases?
Aggregate Demand is a total demand for a country’s goods and services at a given price level in a given period of time.
There are several reasons for decrease in Aggregate Demand curve. To explain them initially we need to know the formula for AD= C+I+G+(X-M).
Where:
• C- consumption
• I- investment
• G- government spending
• X- export
• M- import
Thus, a decrease in any components of AD will lead to downward slope of the AD curve.
Consumption may be decreased because of decrease in disposable income. As we know consumption is the function of disposable income. If disposable income decreases, consumption will also decrease. There are many ways that consumption can decrease. An increase in taxes would have this effect. Similarly, a decrease in income--holding taxes stable--would also have this effect. Finally, a decrease in the marginal propensity to consume or an increase in the savings rate would also decrease consumption.
The second component which might lead to a decrease in AD is Investment. We can say that Investment is the function of interest rates. Therefore if the interest rate rises, investment is falling. It is likely that people are likely to save money rather than borrow with high interest rates. Therefore it also causes the Aggregate Demand curve slope downward.
The term variable that will lead to a shift in the aggregate demand curve is Government expenditure. G is one of the fiscal policy measures. If the government decides to cut spending, it may lead to a decrease in AD.
The fourth term that will lead to a shift in the aggregate demand curve is NX(e). This term means that net exports, defined as exports less imports, is a function of the real exchange rate. As the real exchange rate rises, the dollar becomes stronger, causing imports to rise and exports to fall. Thus, policies that raise the real exchange rate though the interest rate will cause net exports to fall and the aggregate demand curve to shift left.
Also AD may decrease because of fall in consumer confidence. A decrease in consumer confidence brought on by concerns that the economy might be headed for troubled times, which then prompt the household sector to spend a smaller proportion of disposable income on consumption.
Why does Aggregate Demand slope downward?
Aggregate Demand is a total demand for a country’s goods and services at a given price level in a given period of time.
The formula is AD= C+I+G+(X-M).
There are several reasons for downward slope of the AD curve:
• The Real Balance effect states that the inverse relationship between the price level and the quantity demanded of Real GDP is established through changes in the value of monetary wealth
• A fall in the price level causes purchasing power to rise, which increases a person’s Monetary Wealth. As people become wealthier, the quantity demanded from the GDP rises.
• A rise in the price level causes Purchasing Power to fall which decreases a person’s monetary wealth
• The Interest Rate Effect states that the inverse relationship between the price level and the quantity demanded of Real GDP is established through changes in household and business spending that is sensitive to changes in interest rates.
• The International Trade Effect states that the inverse relationship between the price level and the quantity demanded of Real GDP is established through foreign sector spending, which includes US spending on foreign goods and foreign spending on US goods.
Aggregate Demand is a total demand for a country’s goods and services at a given price level in a given period of time.
There are several reasons for decrease in Aggregate Demand curve. To explain them initially we need to know the formula for AD= C+I+G+(X-M).
Where:
• C- consumption
• I- investment
• G- government spending
• X- export
• M- import
Thus, a decrease in any components of AD will lead to downward slope of the AD curve.
Consumption may be decreased because of decrease in disposable income. As we know consumption is the function of disposable income. If disposable income decreases, consumption will also decrease. There are many ways that consumption can decrease. An increase in taxes would have this effect. Similarly, a decrease in income--holding taxes stable--would also have this effect. Finally, a decrease in the marginal propensity to consume or an increase in the savings rate would also decrease consumption.
The second component which might lead to a decrease in AD is Investment. We can say that Investment is the function of interest rates. Therefore if the interest rate rises, investment is falling. It is likely that people are likely to save money rather than borrow with high interest rates. Therefore it also causes the Aggregate Demand curve slope downward.
The term variable that will lead to a shift in the aggregate demand curve is Government expenditure. G is one of the fiscal policy measures. If the government decides to cut spending, it may lead to a decrease in AD.
The fourth term that will lead to a shift in the aggregate demand curve is NX(e). This term means that net exports, defined as exports less imports, is a function of the real exchange rate. As the real exchange rate rises, the dollar becomes stronger, causing imports to rise and exports to fall. Thus, policies that raise the real exchange rate though the interest rate will cause net exports to fall and the aggregate demand curve to shift left.
Also AD may decrease because of fall in consumer confidence. A decrease in consumer confidence brought on by concerns that the economy might be headed for troubled times, which then prompt the household sector to spend a smaller proportion of disposable income on consumption.
Why does Aggregate Demand slope downward?
Aggregate Demand is a total demand for a country’s goods and services at a given price level in a given period of time.
The formula is AD= C+I+G+(X-M).
There are several reasons for downward slope of the AD curve:
• The Real Balance effect states that the inverse relationship between the price level and the quantity demanded of Real GDP is established through changes in the value of monetary wealth
• A fall in the price level causes purchasing power to rise, which increases a person’s Monetary Wealth. As people become wealthier, the quantity demanded from the GDP rises.
• A rise in the price level causes Purchasing Power to fall which decreases a person’s monetary wealth
• The Interest Rate Effect states that the inverse relationship between the price level and the quantity demanded of Real GDP is established through changes in household and business spending that is sensitive to changes in interest rates.
• The International Trade Effect states that the inverse relationship between the price level and the quantity demanded of Real GDP is established through foreign sector spending, which includes US spending on foreign goods and foreign spending on US goods.
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