Movements along and shifts in aggregate demand

Overview

What moves the economy along the aggregate demand curve, what shifts the whole curve, and why a policy change does the second rather than the first.

What you need to know

Answer each one before you reveal it.

Questions from this subtopic

Each one with the model answer underneath.

1. 1

   What causes a movement along the aggregate demand curve, and what causes the whole curve to shift?

   Model answer

   A movement along the curve is caused only by a change in the general price level, which alters the real output demanded through the real balance, interest rate and international trade effects. A shift is caused by a change in any determinant of planned spending other than the price level, such as consumer confidence, interest rate policy, government spending, taxation or the exchange rate. A shift means a different quantity of real output is demanded at every price level, not just at one.

2. 2

   Explain the difference between a fall in the general price level and a fall in aggregate demand.

   Model answer

   A fall in the general price level is a movement down along an unchanged aggregate demand curve, and it increases the quantity of real output demanded. A fall in aggregate demand is a shift of the whole curve to the left, meaning less real output is demanded at every price level. The two have opposite implications for output, so treating them as the same thing reverses the analysis.

3. 3

   The Bank of England raises interest rates. Explain whether this shifts the aggregate demand curve or causes a movement along it.

   Model answer

   It shifts the curve. The change in interest rates has not come from a change in the general price level; it is a policy decision that alters the cost of borrowing and the reward for saving at every price level. Dearer credit reduces investment and interest-sensitive consumption, so on a diagram with the general price level on the vertical axis and real national output on the horizontal axis the aggregate demand curve shifts to the left. Only interest rate changes caused by a change in the price level itself produce a movement along the curve.

4. 4

   Describe what happens on an aggregate demand diagram when consumer confidence collapses.

   Model answer

   With the general price level on the vertical axis and real national output on the horizontal axis, the aggregate demand curve shifts inwards to the left, from AD1 to AD2. At every price level, households now plan to spend less and save more against the risk of losing their jobs, so real output demanded is lower throughout. The horizontal distance between the two curves measures the reduction in planned spending at any given price level.

5. 5

   Why can a leftward shift of aggregate demand be described as a fall in demand at every price level rather than at one price level?

   Model answer

   A shift is a change in the whole schedule, so the new curve lies to the left of the old one along its entire length. Whatever the general price level happens to be, planned spending on domestic output is now lower than it was before. This is what distinguishes a shift from a movement, which changes only the point occupied on a single unchanged schedule.

6. 6

   A rise in the general price level reduces exports. Is this a shift of aggregate demand or a movement along it?

   Model answer

   It is a movement along the curve. The loss of exports is the international trade effect at work, and that effect is one of the reasons the curve slopes downwards in the first place, so it is already built into the shape of the existing schedule. Drawing a leftward shift as well would count the same effect twice. A shift would require exports to change for some other reason, such as a change in the exchange rate or in foreign incomes.

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