Downward sloping AD

If inflation is high then

• Consumption will fall as the purchasing power of household’s money will not go as far with higher prices

• Exports will fall (as UK goods are expensive relative to other countries) + Imports will rise (as UK consumers look for cheaper options abroad)

• A change in the price level results in a movement along the AD curve

• A change in one of the components of AD will cause a shift in the aggregate demand curve

• I.e. an increase in C, I, G, X and a decrease in M will shift AD curve outwards

Aggregate Demand

AD is calculated using:

C + I + G + ( X - M )

C is the most important component and represents between 60% to 65% of the overall calculation

At an inflation level of 2%, the AD curve gives a level of output of Y1 This level of output will be associated with a particular level of unemployment which we will call U = 5%

At a higher rate of inflation (3.0%) C, I and (X-M) all have negative effects on AD – R.O falls to Y2 The lower level of National Income requires fewer units of labour – unemployment rises to 7% shown by U = 7%