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Describe Exogenous Events That Can Shift The Aggregate Demand Curve

Referencing Styles : MLA | Pages : 1

A demand curve actually shows the relationship between price of any product and quantity demanded. Now through the demand curve, it is possible to estimate the quantities that can be demanded by the economy at a given price. Now aggregate demand curve is showing the fact that at a particular price, economies demands particular set of goods. From the aggregate demand curve, the consumption preference of the economy and will be beneficial for the identification of customers. One of the major characteristics of the demand curve is the negative relationship between price and quantity demanded. This means with the increase in price by one unit will definitely decrease the quantity demanded of that goods. This assumption is directly coming from law of demand that claims that everything is remaining constant, Ceteris Peribus, one unit increase in the price will decrease the quantity demanded of that products. This is the main reason why the shape of the demand curve is downward sloping in nature. Now the equilibrium in the goods market can be formed at the position where the aggregate demand curve is meeting aggregate supply curve.

 

Figure 1: Equilibrium condition

(Source: Created by author)

Now there are certain events that will force the shift of the demand curve. However, the shift of the demand curve can happen in both direction. The shift of aggregate demand curve is mainly shifting the equilibrium level. Rightward shift of the aggregate demand curve is mainly increasing the demand curve that is actually improving the consumption pattern of consumers. Leftward shift of the demand curve is mainly going to shift the equilibrium in the leftward directions.

The exogenous factors that are helping in the shift of the demand curves are discussed below.

Price of the goods

Price of the goods are one of the main factors that is making the demand of the customers to have deep impact. If the price of the goods is increased then the consumers will definitely consume less. Continuous increase in the price of the products, will force the consumers to shift to cheap products that are having less costly. This will force the consumers to shift the aggregate demand curve towards left. Now there are two kinds of products in the form of substitute goods and complementary goods. However, the price change of the products is solely depending on the elasticity of the products.

Now the price rise of the substitute products will obviously shift the demand and consumers will switch their products to consume some other products. Now the price rise of the complement products will obviously depending on the price elasticity. The price rise of the complementary products is definitely going to increase the consumption expenditure of the consumers. The whole effect of the shift in aggregate demand curve is that increase in price will definitely shift towards leftward direction.

 

Figure 2: Leftward shift of demand curve

(Source: Created by author)

Income of the customers

Income of the customers is an important factors that actually impacts the consumer demand of the goods and services. Now income of the consumers is an important concepts that has been directly impacting the demand of the customers. If the income of the customers get increased then the demand of the customers will obviously increase. This is because with the increase in income, the consumers will demand more of the goods and services that are being produced within an economy. Rise in the income of the consumers will definitely shift the aggregate demand curve towards right making the price and quantity demanded to be increased.

 

Figure 3: increase in demand curve due to increase in income

(Source: Created by author)

Monetary and Fiscal Policies

The government has some ability to impact AD. They can spend money or increase taxes in order to influence how consumers spend or save. An expansionary fiscal policy causes AD to increase, while a contractionary monetary policy causes AD to decrease. This is having strong impact on the shift of AD. Both the monetary and fiscal policy is making the changes to happen. Government spending is one component of AD. Thus, higher government spending will cause AD to shift to the right, as in Figure 1, while lower government spending will cause AD to shift to the left, as in Figure 2. For example, U.S. government spending declined by 3.6% of GDP during the 1990s, from 22.2% of GDP in 1992 to 18.6% of GDP in 1999. However, from 2008 to 2009, U.S. government spending increased from 20.7% of GDP to 24.7% of GDP. If changes of a few percentage points of GDP seem small to you, remember that since GDP exceeded $14 trillion in 2009, a seemingly small change of 1.0% of GDP in annual spending is equal to more than $140 billion.

Smooth performances of economy

Consumer and business confidence often reflect macroeconomic realities; for example, confidence is usually high when the economy is growing briskly and low during a recession. However, economic confidence can sometimes rise or fall for reasons that do not have a close connection to the immediate economy, like a risk of war, election results, foreign policy events, or a pessimistic prediction about the future by a prominent public figure. U.S. presidents, for example, must be careful in their public pronouncements about the economy. If they offer economic pessimism, they risk provoking a decline in confidence that reduces consumption and investment and shifts AD to the left, and in a self-fulfilling prophecy, contributes to causing the recession that the president warned against in the first place. A shift of AD to the left, and the corresponding movement of the equilibrium, from E0 to E1, to a lower quantity of output and a lower price level, can be seen in the following interactive graph.

 

Figure 4: shift in AD

Source: Created by author

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