AGGREGATE DEMAND DETERMINANTS:

An assortment of ceteris paribus factors other than the price level that affect aggregate
demand, but which are assumed constant when the aggregate demand curve is constructed.
Changes in any of the aggregate demand determinants cause the aggregate demand curve
to shift. The specific ceteris paribus factors are commonly grouped by the four, broad
expenditure categories--consumption expenditures, investment expenditures, government
purchases, and net exports.
Aggregate demand determinants are held constant when the aggregate demand curve is
constructed. A change in any of these determinants causes a shift of the aggregate demand
curve.
The determinants work through the four aggregate expenditure categories--consumption
expenditures, investment expenditures,government purchases, and net exports. Should any
specific aggregate demand determinant change, it must affect the aggregate demand curve
through one of the four aggregate expenditures.
A few of the more notable determinants that tend to stand out in the study
of macroeconomics and the analysis of the aggregate market are:
Interest Rates: Interest rates affect the cost of borrowing and thus both consumption
and investment expenditures. Interest rates are a component of investment-driven
business cycles and play a key role in monetary policy.

Federal Deficit: The federal deficit is comprised of government purchases, which is
one of the four basic expenditures, and taxes, which affects the amount
of disposable income available for consumption. Changes in the federal deficit
commonly result from the use of fiscal policy.

Expectations: Household and business expectations of future business-cycle
conditions, especially inflation and unemployment, affect consumption and
investment expenditures.

Money Supply: The quantity of money circulating in the economy directly affects the
buying capabilities of all four sectors and thus affects all four expenditure categories-
-consumption, investment, government purchases, and net exports. Control of the
money supply is the key to monetary policy.

Consumer Confidence: The degree of household sector optimism or pessimism
affects current consumption expenditures.
A host of other specific aggregate demand determinants also surface from time to time,
including exchange rates between domestic currency and foreign currency, the
accumulation of physical wealth especially business capital and household durable goods,
and the accumulation of financial wealth especially changes in the value of the stock
market.
Shifting the Aggregate Demand Curve
The exhibit to the right presents a standard
aggregate demand curve. It is negatively-sloped,
capturing the specific one-to-one relationship
between the price level and aggregate expenditures.
The ceteris paribus factors, that is, the aggregate
demand determinants, are assumed to remain
constant with the construction of the curve.
Analogous to other determinants, aggregate
demand determinants shift the aggregate demand
curve. A change in any of the determinants can
either increase or decrease the aggregate demand
curve. An increase in aggregate demand is
illustrated by a rightward shift in the aggregate
demand curve. A decrease in aggregate demand is
illustrated by a leftward shift. Click the [Increase in
AD] and [Decrease in AD] buttons for a
demonstration.
What does it mean to have an increase in demand?
It means that for every price level, the four sectors
have an increase in aggregate expenditures on real production. A decrease in demand is the
exact opposite. For every price level, the four sectors have a decrease in aggregate
expenditures on real production.









Shifting the Curve





Four Determinants
Consider now several specific determinants that work through each of the four broad
expenditure categories.
Consumption: Household consumption expenditures, being from a rather large, rather
diverse group, are influenced by a lot of things. Here is a short list:
Physical wealth is the material, tangible possessions of the household sector,
especially durable goods like cars, furniture, and kitchen appliances. An increase in
physical wealth generally reduces consumption expenditures. If consumers have
recently purchased a lot of durable goods, then they have less need to buy more,
with a subsequent decrease in consumption and aggregate demand.

Financial wealth is money, stocks, bonds, mutual funds, bank accounts, and other
documents that give consumers a claim to goods, resources, or productive assets.
When consumers acquire more financial wealth, they tend to spend more freely, with
a subsequent increase in consumption and aggregate demand.

Interest rates are another key consumption determinant. Becauseinterest rates
affect the cost of borrowing and because many durable goods are purchased with
borrowed funds, higher interest rates reduce consumption and aggregate demand,
and lower interest rates do the reverse.

Expectations of future economic conditions are also an important determinant.
Households want to buy at the lowest price possible. If they expect that the price
level will rise (that is, they expect rising inflation), then they are inclined to buy
more today, causing consumption expenditures and aggregate demand to increase.
Investment: Investment tends to be the most volatile of the four expenditure categories
with a large assortment of influences. The first three determinants listed are comparable to
consumption determinants.
Interest rates work much the same for investment as for consumption. Investment
expenditures for capital goods are usually financed with borrowed funds. If interest
rates change, then the cost of borrowing changes and so too does the overall cost of
the investment. Higher interest rates mean less investment and a decrease in
aggregate demand.



Physical wealth possessed by the business sector includes capital goods. This
determinant works for investment expenditures much like that for consumption
expenditures. In this case the physical wealth is capital, the object of investment.
The business sector is less inclined to invest in capital goods, if it has recently
accumulated a lot of capital goods through investment. A boost in the amount of
capital is bound to cause (eventually) a decline in investment and aggregate
demand.

Expectations of future economic conditions is also an important determinant working
through investment expenditures. If the business sector sees an improving economy
on the horizon, with expectations of greater sales and profits, they are more inclined
to expand investment now, in spite of current conditions. This, of course, boosts
aggregate demand.

Capital prices are another key determinant working through investment. Invoking
the basic law of demand, if the price of capital increases, the business sector
decreases the quantity of capital demanded. This results in a decrease in investment
expenditures and aggregate demand.

Technology is the last but not the least determinant affecting aggregate demand
through investment. Technological advances enhance the need to invest in capital. A
new technology requires new capital, different capital, capital to implement the
technology. Technological advances invariably trigger an increase investment and
aggregate demand.
Government Purchases: The government sector plays by its own set of rules. In fact,
they make the rules. But there is one unavoidable rule that the government sector must
follow--when government spends more (or less) on government purchases, aggregate
demand increases (or decreases). If elected leaders decide to spend big-bucks on the
military, or education, or the space program, or highways, or any number of other
worthwhile products, then government purchases increase and so too does aggregate
demand.
The specific influences that might entice government to change its spending ways include:
Fiscal Policy: At the federal level, the desire to counter instability caused by other
expenditures though fiscal policy is always a possibility. If aggregate demand
decreases because of less spending from the household or business sectors, then the
government sector is often inclined to spend more. Alternatively, if aggregate
demand increases to the point of triggering inflation, then the government is likely to
spend less.


Politics: Political considerations are almost always bubbling near the surface of
government spending. Perhaps the political winds blow in the direction of reducing
the federal deficit. Such a force could decrease government purchases and aggregate
demand. Or perhaps a rather vocal and financially powerful interest group convinces
political leaders to spend more on worthy activities, like the space program, national
defense, or environmental quality. This is bound to increase government purchases
and aggregate demand.

State and Local Taxes: At the state and local level, which accounts for about two-
thirds of total government purchases, a key determinant is tax collections. A boost in
state and local tax collections, which usually happens when the economy is strong,
causes state and local government purchases to increase. And when the economy is
weak, tax collections fall, and so too do state and local government purchases.
Net Exports: With the inherent diversity of the foreign sector (which includes well over a
hundred distinct national governments, almost six billion people, and hundreds of thousands
of assorted foreign businesses), a number of things can influence the net-export
expenditure contribution to aggregate demand. But here is a handful.
Global Prosperity: The health of foreign economies is one determinant. When other
nations are in fine economic shape, their consumers tend to buy more goods,
including more goods produced in the other countries. That means the domestic
economy exports more to them and aggregate demand increases.

Exchange Rates: Currency exchange rates are another determinant of net exports.
An exchange rate is the price of one nation's currency in terms of another. When this
rate changes, it affects the relative prices of exports and imports. When those
relative prices change so too do exports and imports and thus net exports and
aggregate demand.

Trade Barriers: The assortment of trade barriers, tariffs, restrictions, and subsidies
that nations tend to use to gain a competitive advantage in the game of foreign
trade are also a key determinant. Greater restrictions on imports tend to increase
net exports and thus aggregate demand--at least in the short run. In the longer run,
other nations tend to retaliate by imposing their own restrictions on the export side
and that can reduced aggregate demand.




Two Changes
Shifts of the aggregate demand curve, brought about by such things as fiscal or monetary
policies, changes in investment expenditures, or changes in consumer confidence, are often
the source of disequilibrium in the aggregate market. Such disequilibrium then results in
changes in the price level. The key is that aggregate demand determinants CAUSE shifts of
the aggregate demand curve which CAUSE disequilibrium which then CAUSES changes in
the price level.
This suggests an important difference between two related changes--a change in aggregate
demand and a change in aggregate expenditures.
A change in aggregate demand is any shift of the aggregate demand curve. With this
change, the entire curve shifts to a new location. A change in aggregate demand is
caused by a change in the aggregate demand determinants. This is comparable to
a change in demand in the analysis of the market.

A change in aggregate expenditures is a movement along a given aggregate demand
curve. This change involves the movement from one point on the existing curve to
another point on the SAME curve. The curve does not move. A change in aggregate
expenditures is caused by a change in the price level, and ONLY a change in the
price level! This is comparable to a change in quantity demanded in the analysis of
the market.