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4.3.5 causes of a shift in the AD curve

4.3.5 causes of a shift in the AD curve

Shifts in the AD Curve

Definition

Shift in the AD curve: a change in planned spending at every price level, caused by a change in a component of AD rather than by the price level itself.

Direction of the Shift

  1. A rise in C, I, G or (X − M) shifts AD to the right, since AD = C + I + G + (X − M).
  2. A fall in C, I, G or (X − M) shifts AD to the left.
Key Idea
  • Anything that raises planned spending at each price level shifts AD to the right.
  • Anything that lowers planned spending at each price level shifts AD to the left.

Common Causes

  1. Confidence: optimistic firms invest more, raising I and shifting AD right.
  2. Interest rates: a cut lowers the cost of borrowing, raising C and I.
  3. Income and taxation: an income-tax cut raises disposable income and so C.
  4. The exchange rate: a weaker currency raises (X − M) by making exports cheaper and imports dearer.
  5. Conditions abroad: a recession in trading partners cuts foreign demand for exports X, shifting AD left.
  6. Fiscal policy: higher government spending raises G and shifts AD right directly.

Causes of a shift in the AD curve

Chain of Reasoning

  1. A cause changes one component of aggregate demand.
  2. Planned spending at every price level then rises or falls.
  3. So the whole AD curve shifts right or left.
Example
  • Suppose a central bank cuts its policy rate from 4% to 3%.
  • Repayments on a £200,000 mortgage fall, so households have more to consume, and firms' projects become more profitable.
  • This raises the C and I components of AD.
  • Planned spending rises at every price level, so AD shifts to the right.

Size of the Shift

  1. The larger the change in the component, the further AD shifts.
  2. A given rate cut shifts AD more when confidence is high and households actually borrow.
  3. In a deep recession, gloomy expectations can mute the shift even after a large cut.

Shift Versus Movement

  1. A component change at a given price level moves the whole curve.
  2. A price-level change only moves the economy along the existing curve.

Causes of a shift in the AD curve

Exam technique
  • Say which component changed and in which direction AD shifts.
  • Label the vertical axis average price level and the horizontal axis real output.
Common Mistake
  • Do not treat a price-level change as a shift of the curve.
  • A price-level change is a movement along the curve, not a shift.
Self review
  • What causes the AD curve to shift?
  • Name three causes of a rightward shift in AD.
  • What is the difference between a shift and a movement along AD?
  • Why is a price-level change not a shift?
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Aggregate demand is total planned spending in an economy: AD=C+I+G+(X−M)AD = C + I + G + (X - M)AD=C+I+G+(X−M). Here, CCC is consumption, III is investment, GGG is government spending, and (X−M)(X - M)(X−M) is net exports.

A shift in the AD curve is a change in planned spending at every price level. It is caused by a change in one of the components of AD, rather than by a change in the price level itself.

If CCC, III, GGG, or (X−M)(X - M)(X−M) rises, AD shifts right. If any of these components falls, AD shifts left.

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What happens to AD when planned spending rises at every price level?

4.3.5 causes of a shift in the AD curve Revision Guide

  1. Intl A Level
  2. /Economics
  3. /4.3.5 causes of a shift in the AD curve

Revision notes for CIE Intl A Level Economics 4.3.5 causes of a shift in the AD curve: explanations and worked examples.