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Shifts in aggregate demand

If a factor of aggregate demand changes in response to anything other than a change in the price level shifts aggregate demand. In this video, we explore the shifters of AD and factors that might shift aggregate demand to the left (a decrease in AD) or to the right (an increase in AD). Created by Sal Khan.

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  • blobby green style avatar for user pasindumuth
    when the government raises taxes, the consumers spend less, so the aggregate demand is less. But the money that was given as taxes go to the government. That means that government spending should increase. Does all of this mean that the actual left and right movement of the demand curve result in no movement of the curve, and thus no change in GDP?
    (9 votes)
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  • leaf green style avatar for user hasoonax96
    I don't quite understand how the saving interest rate effect works out. If saving rates go up and by extension investment goes up and thus Real GDP grows, isn't there something else happening as well. As Saving rates go up, money spent is going down. Essentially, as saving rates go up, people will spend less (spending rates going down) and as we all know spending rates going down dramatically are almost always associated with slumps in the economy. So how can these both work at the same time? If investment spending increases and thus more business is made etc. , who will buy form those businesses if spending rates are low?
    (4 votes)
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    • leaf green style avatar for user Sammy K
      As saving rates go up, money spent does not go down. When a person saves money, they give the money to a bank and the bank promises to return that money upon request. In the meantime, what does the bank do with the money? The bank might invest it, in which case the money goes to some firm and is spent building new factories, buying the inputs to production, or paying employees. The bank might loan it to individuals, congratulations, you just bought somebody a new car. Or the bank might loan the money to the federal government by buying treasury certificates, in which case the federal government will spend it (along with trillions of other dollars that they don't have). So if you save money, you haven't reduced spending, you've just allowed other people to spend your money for you.

      This all assumes of course, that people save money by depositing it in a bank. If money is saved by stuffing cash into a mattress, then yes, spending does go down, but not many people do that any more.
      (12 votes)
  • blobby green style avatar for user Harsh Verma
    Shouldn't an overall decrease in the prices of all the goods decrease the GDP of the country because the GDP is defined as the sum of prices of all the goods produced ? ( considering the production does not increase too much ).
    (4 votes)
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  • leaf green style avatar for user Will
    Since a change in Price causes a change in Consumption, Investment, and/or Net Exports, why does that NOT shift the Aggregate Demand Curve, but rather causes a movement along the curve, yet any policy that causes a change in C or I DOES shift the AD Curve?
    I hope my question was clear enough! :)
    (1 vote)
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    • leaf green style avatar for user Jeffrey Pierce
      This is a common trap for economics students to fall into! :-) Think back to the law of demand that you learned earlier: An increase in price leads to a decrease in the quantity demanded of a good or service, and vice-versa. The willingness and ability of consumers to purchase the product doesn't change in response to changes in price, but only in response to various non-price determinants, such as changes in tastes/preferences, number of customers, etc.

      For instance, reducing the price of blue jeans will increase the quantity demanded of blue jeans. A change in young people's taste toward torn jeans will shift the overall demand curve for blue jeans to the right, representing an increased willingness and ability to buy blue jeans at each price.

      This is true of all types of spending or consumption demand curves. For instance, on the Investment Demand curve, as the price to borrow money (the real interest rate) falls, the quantity of Investment increases. But the actual willingness and ability of businesses to invest at each real interest rate will only change -- that is shift the ID curve -- in response to factors other than the r%, such as existing capital stock or expected returns on the investment.

      Now, think of Aggregate Demand as just what term says: It's the sum total of every demand curve that exists in the macroeconomy. Thus, the Law of Demand holds for AD just as it does for single-product demand curves: As overall price level falls, the quantity demanded of all goods and services will increase; and thus, Real GDP (output) will increase to meet that consumer demand. AD, measuring the combined willingness and ability of all consumers in the nation, will only shift (increase or decrease) in response to the non-price determinants of AD you learned in class.
      (11 votes)
  • male robot hal style avatar for user Tao Cheng
    if the price goes down would lead real GDP growth, isn't it contradict with deflation theory ...cuz deflation is price goes down
    (3 votes)
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    • leaf red style avatar for user Pranshu Sejpal
      In your statement, you're assuming that the fall in the price levels do not affect anything else. The source is very important. If the fall in price levels is due to fall in demand. It is self-explanatory to say that the GDP will fall.
      Another source is a new technological discovery or fall in the price levels of oil (anything that reduces cost of production) then it is clear that this would lead to gdp growth. My point is the source is very important.
      But for your question lets forget the source and think about the consequences. Deflation is known to have a cyclical effect. For instance, a fall in prices -> fall in income for businesses -> fall in wages/people laid off -> fall in personal income -> fall in demand -> fall in prices (back again). That's why people are scared of it.
      Apologies if I made it complicated. An economy always is :p
      (5 votes)
  • aqualine tree style avatar for user Brooke
    So if it's a change in price level that effects consumption, investment, etc then you don't shift the graph, but if it's the other way around then you shift the graph?
    (2 votes)
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  • female robot amelia style avatar for user Fernanda Palacios
    In the case of a tax cut, how can AD shift to the right if indeed people might spend more, which increases consumption, but now the government does not receive that money from the taxes and reduces its government spending in the same amount.?
    (3 votes)
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    • ohnoes default style avatar for user Tejas
      Sal said that the scenario was specifically about a tax cut but not a corresponding spending cut, so the government creates a deficit. If there were a tax cut with a corresponding spending cut, aggregate demand would not change.
      (2 votes)
  • mr pants teal style avatar for user Madihah Karim
    At , Sal said C, I, G and NX make up the real GDP. Aren't these the components of aggregate demand? If yes, then how is real GDP and AD made up of the same factors? Doesn't price have anything to do with it?!
    (2 votes)
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    • male robot hal style avatar for user Andrew M
      No. Y = C + I + G + NX.
      This is two ways of looking at the same thing.
      Income = expenditures. Every dollar spent by someone is income to someone else, so they have to be equal. The price level does not matter here because the price to the seller is the same as the price from the buyer.
      (3 votes)
  • leaf red style avatar for user sankeerth
    and doesnt Y stand for income??
    (1 vote)
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  • blobby green style avatar for user Gbemileke Bello
    Should we abandon the model of aggregate demand and aggregate supply as a way to understand aggregate economic behaviour?
    (2 votes)
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    • male robot hal style avatar for user Tim Rizk
      Abandoning "the model of aggregate demand and aggregate supply" would essentially be abandoning economics. We should however, seriously rethink the idea of ceteris paribus (all things being equal), because all things are never equal especially on a macroeconomic level. This gross oversimplification can easily lead to wrong conclusions and poor economic policy (i.e. trickle-down theory).
      (1 vote)

Video transcript

In the last video, we started thinking a little bit about the aggregate demand curve and why it might be downward sloping and we actually reviewed some of the possible justifications for a downwards sloping aggregate demand curve, the wealth affect. Remember, all other things equal. We're not talking about changing the amount of money in people's pockets or changing their outlook or changing their jobs or changing the level of investment, we're just saying if prices were to just go down, all of a sudden people would have ... They'd feel richer because they could buy more with what they have and so they might ... They might want to buy more, demand more and so those things would have to be produced and so real GDP would go up. Real GDP would go up and that was the Wealth Affect and likewise if prices went up, the opposite would happen. People would have less money or they would have the same amount of money in their pockets, but they could buy less with it and so they would demand less and real GDP would go ... real GDP, real GDP would go down. The other factor or justification I should really say, because these are really just theories so you should view them with huge grains of salt, is that if prices ... If the general level of prices were to go down, then interest rates would go down and if interest rates would go down, there would be more investments. So prices go down, more investment. GDP goes up. Prices go up. Interest rates would go up. Real GDP would shrink and we would go over here and then the last one dealt with exports and that if general price levels went down, both interest rates would go down and just things would be cheaper in that country and so we might have more net exports. So once again, prices go down. GDP expands. Prices go up. GDP ... GDP contracts. All of these are possible theories or justification for a downward sloping aggregate demand curve. What I want to do in this video is think about what, all other things equal, what might cause the aggregate demand curve to shift and how would it cause the aggregate command curve to shift? And to think about that, to think about what the possible causes could be, we just have to think about well, what are all of the things that make up GDP? And you might remember GDP and we use Y as the variable for GDP. It's equal to ... It's equal to consumption plus investment plus government spending plus net exports and this is a pretty good way to think about what are all the things that might shift the aggregate demand curve. First of all you could think about consumption, if there was some factor that would cause consumption to increase. So maybe you have a ... something like a tax cut. You have a tax cut and you don't have a corresponding government spending cut, so essentially the government would have to. If the government is already spending all the money it has, it would probably have to go in to debt to allow this tax cut to happen, but if you had this tax cut all of a sudden people would have more money in their pockets and they might be able to demand more. That would cause ... that would cause consumption to go up and it would make ... it would make aggregate ... aggregate productivity or aggregate demand go up. So if you have a tax cut, something like that for consumers, that might shift aggregate demand to the right at any given level of prices, people are going to demand more. Likewise, if you had a tax increase and that tax increase wasn't ... also didn't have more government spending, then aggregate demand would go the other way. So tax cut, it would shift to the right for people. If there was a tax increase, all other things equal, it would probably shift to the left, if you believe this model. Likewise, investment. Maybe government ... Maybe the government allows all of a sudden companies to write-off investments that they make this year or there are some tax benefit from making investments in this year and so you could have situations where for whatever reason investment ... investment were to go up or it could just be a natural ... There might be a newly discovered industry where all of a sudden or resources that people start investing in to find that thing and once again that would cause aggregate GDP to go up, more investment. And then the third piece of this, we have the direct government. We have the government right over here. So if the government says, "Hey, maybe ... Maybe we're going to incur", assuming they're already spending as much money as they have or maybe more than they have, "We're going to incur even more ... even more "debt to ... to spend more money." So if government spending were to go up, If government spending were to go up, that would also shift the demand curve to the right and all other things equal, if government spending were to go down that might shift demand curve to the left and the last one and this might be a little bit common sense to you. If for whatever reason, maybe our country all of a sudden produces some goods and services that the rest of the world really, really, really values. They can't produce it themselves and that net exports were to go up, if net exports were to go up, that means more people in other countries are buying our goods and services, then that, too, would cause aggregate demand to go up or on the other hand, if all of a sudden people in our country started saying, "Hey, we don't want to buy the stuff that we" "produce. We want to buy what the people on the other" "side of the ocean are producing." That would make aggregate demand go down. So to really think about how aggregate demand shifts, you just have to really think about the components of GDP and how different macro ... macro things might impact those components of GDP and those will tell you whether at a ... at a given level of prices of goods and services in the economy whether it'll shift demand to the right or to the left.