Aggerate demand model (AD model)

Spending

Causes a shift in the aggregate demand curve

Government Spending

Increase in Gov. spending causes the AD curve to shift to the right.

Decrease in Gov. spending causes the curve to shift to the left, reducing overall demand in the economy.

Taxes

A change in tax rates affects disposable income for consumers, influencing consumption levels and thus shifting the aggregate demand curve.

Lower taxes typically increase demand, while higher taxes decrease it.

Consumption Spending 

Changes in real wealth shifts consumption spending 

Increased wealth typically leads to higher consumption spending; thus, AD increases (shifts right) and vice versa

Decreased wealth results in lower consumption spending and a leftward shift of the AD curve.

Real wealth 

Includes inflation and thus can be compared over time and across various assets.

Increases in price level decreases real wealth which decreases consumption and AD

Real wealth = nominal/price level or W/P

Nominal Wealth 

excludes inflation

Refers to the face value of assets without adjusting for inflation, making it difficult to compare over time.

Expected Inflation

If inflation is expected to increase, consumption increases now to avoid higher future prices.

This can lead to a temporary boost in aggregate demand.

Types of Spending

Consumption

Investment

government spending

Net exports.

All affect and contribute to aggregate demand,

Investment Spending 

Changes in real interest rates cause shifts in investment spending.

Lower rates encourage borrowing and spending on capital goods and AD goes up

Higher rates discourage borrowing and reduce capital investments. and AD goes down

Net exports

Changes in foreign incomes cause shifts in net exports

• Higher foreign incomes increase exports and AD goes up 

• Lower incomes decrease and AD goes down

Changes in exchange rate cause shifts in net exports

• If yen appreciates or dollar depreciates exports goes up and AD goes up

• If yen depreciates or dollar appreciates, exports go down and AD goes down.