Aggregate demand worksheet

Please construct the following activity in a word document, and submit as an

assignment

Objective: To demonstrate an understanding of the circular flow of income and factors

that may cause shifts in AD.

1. Circular Flow of Income

The circular flow of income diagram is critical to understanding how a national

economy operates. It is used to show the relationship between changes in aggregate
demand and the four macroeconomic objectives.

Your task: Draw the circular flow of income diagram, including all sectors of the model
and their corresponding injections and withdrawals/leakages. Write down which of the
following are changes in injections and which are changes in withdrawals from the
nation’s circular flow of income. Assuming ceteris paribus, specify whether the change
in each case will reflect an increase or a decrease in aggregate demand.

Example:
The government raises tax allowances — raising tax allowance means that the income
that is not taxable has been increased. This will act as an injection in the circular flow of
income as consumers now will have more money to spend on goods and services. AD
will increase as C (consumption) increases.

Your turn now. Follow the example above to explain briefly the scenarios below:

The government cuts spending on infrastructure.

- Decrease in aggregate demand (AD) due to lower government spending.
Firms borrow more money to expand their production facilities as they anticipate an
increase in consumer demand.
- Injection into circular flow.
- Due to an increase in investments AD increases.
A depreciation of the exchange rates makes holidays abroad less desirable.
- Withdrawal from circular flow
The government has decided to lower interest rates.
- Injection into circular flow.
- Increase in AD due to higher investment.
Other countries are beginning to recover from recession.
- Injection into circular flow.
- Increase in AD due to higher exports.
2. Changes in Aggregate Demand

For each scenario below, explain which AD component will be affected and draw on an
AD/AS macroeconomic diagram how the AD will change as a result of the changing
condition stated in the example. How will this affect real GDP and price level?

The government has increased the income tax rates on personal income.
- Decrease in consumption
- A leftward shift in the AD curve
- Lower real GDP and price levels

Interest rates have decreased.

- Investment increases
- The AD curve shifts to the right
- Higher real GDP and price levels
The level of income of people living in a trading partner economy has risen.
- Exports decreases
- A shift in the AD curve to the left
- Lower real GDP and price levels