Using diagrams, show the impact of each of the following on the aggregate demand

curve; explain what happens to aggregate demand in each case; and identify the
component(s) of aggregate expenditure involved.
(a) Consumer confidence improves as consumers become optimistic about
future economic conditions.
When consumers become optimistic they spend more money on goods and
services hence AD curve shifts to the right. Component of aggregate
expenditure involved is consumption (C)
The aggregate demand curve
Average price level ($)

AD1 AD2

Real output
(b) The government decides to increase taxes on firms’ profits.
Increasing tax on profits for a firm means profits after paying tax decrease and
investment spending decreases hence a shift to the left of the AD curve.
Component of aggregate expenditure involved is investment (I)

The aggregate demand curve

Average price
Average ($)
price level ($)

AD2 AD1

Real output
(c) Firms become fearful that a recession is about to begin.
Fear of a recession is an indicator of lack of faith in the economy therefore the
AD curve will shift to the left. Component of aggregate expenditure involved
is consumption (C)
The aggregate demand curve
pricelevel
Averageprice
Average ($)
level($)

AD2 AD1

Real output
(d) The government decides to increase its spending on health care services.
The government spending money of merit goods is good for the general economy
therefore an increase in government expenditure the AD curve to shift to the
right. Component of aggregate expenditure involved is government
spending (G)
The aggregate demand curve
pricelevel
Averageprice
Average ($)
level($)

AD1 AD2

Real output
(e) There is a decline in the real estate market (average house prices fall).
A decrease in prices of homes creates an impression that consumers are
less wealthy and cannot afford the houses so they spend less on the house
and the AD curve shifts to the left. Component of aggregate expenditure
involved is consumption (C)
The aggregate demand curve
Average price level ($)

AD2 AD1

Real output
(f) The central bank (a government organisation) decides to increase interest
rates.
Increased interest rates make borrowing more expensive and hence a lower
spending by consumers so AD curve shifts to the left. Component of aggregate
expenditure involved is consumption (C)
The aggregate demand curve
price level
Average price
Average ($)
level ($)

AD2 AD1

Real output
(g) There is an increase in the level of indebtedness of consumers and firms.
A high level of debt for both consumers and firms means that they have to
make high monthly payments to pay back the loans plus the interest
causing less spending and therefore the AD curve shifts to the left.
Component of aggregate expenditure involved is consumption (C) and
investment (I).
The aggregate demand curve
Average price level ($)

AD2 AD1

Real output
(h) Real incomes in countries that purchase a large share of country A’s
exports fall; examine the impact on aggregate demand in country A.
A decrease in country B’s income, which usually spends most of its income on
country A’s exports means that the AD curve of country A will shift to the left.
Component of aggregate expenditure involved is net exports (X-M)

The aggregate demand curve

Average price level ($)

AD2 AD1

Real output
(i) The government lowers personal income taxes (taxes on income of
households).
Lowered tax on personal income creates more disposable income which
allows for households to spend more, as a result the AD curve shifts to the
right. Component of aggregate expenditure involved is consumption (C)
The aggregate demand curve
pricelevel
Averageprice
Average ($)
level($)

AD1 AD2

Real output
(j) New legislation makes property rights more secure.
Laws that make it easier for businesses to acquire credit and secure
property encourage firms to spend money and as a result AD curve shifts
to the right. Component of aggregate expenditure involved is investment
(I).
The aggregate demand curve
Average price level ($)

AD1 AD2

Real output
(k) There is an appreciation (an increase) in the value of the euro relative to
the US dollar; examine the impact on aggregate demand in eurozone
countries (countries that use the euro).
An increase is the value of the euro makes it more expensive in comparison to
the dollar. This will lead to euro spending countries’ exports to decrease and
imports to increase and net exports (X-M) decreases. As a result AD curve shifts
to the left. Component of aggregate expenditure involved is net exports (X-
M)
The aggregate demand curve
Average price level ($)

AD2 AD1

Real output
(l) There is an appreciation (an increase) in the value of the euro relative to the
US dollar; examine the impact on aggregate demand in the United States.
An increase is the value of the euro makes it more expensive in comparison to
the dollar. This will lead to the US’ exports to increase and imports to decrease
and net exports increases. As a result AD curve shifts to the right. Component
of aggregate expenditure involved is net exports (X-M)

The aggregate demand curve

Average price level ($)

AD1 AD2

Real output
(m) A non-governmental organisation (NGO) introduces a programme
providing credit to small farmers, making it easier for small farmers to
borrow to finance the building of irrigation projects.
Increasing access to the ability to borrow will result in investment
spending and as a result the AD curve shifts to the right. Component of
aggregate expenditure involved is investment (I).

The aggregate demand curve

Average price level ($)

AD1 AD2

Real output