Aggregate Demand AD

Question 1

The Aggregate Demand Curve

Answer 1

A fall in the general price level (PL) causes an extension of AD
(movement along the AD curve, higher real Y).
A rise in the PL causes a contraction of AD (movement along AD
curve, lower real Y).
The relationship is INVERSE because:
* Real income effect: As the price level falls, the real value of
income rises, consumers can buy more; higher consumption C
(the real money balance effect)
* Balance of trade effect: A fall in the relative price level of a
country could make foreign-produced goods more expensive,
causing a rise in exports, X and a fall in imports, M.
* Interest rate effect: If price inflation is low this might lead to a
reduction in interest rates and so there is less incentive to save
and consumption C rises; the exchange rate could also
depreciate and improve net exports (X-M).

Question 2

Factors that shift the AD curve

Answer 2

• Changes in real income and employment
• Changes in consumer and business confidence (keynes ‘animal spirits’)
• Changes in household wealth - the wealth effect
• changes in monetary policy
• changes in fiscal policy
  -changes in the exchange rate and in the global economy