Subject 5. Shifts in Aggregate Demand and Supply

Factors that Shift Aggregate Demand

At each price level, the AD curve shifts to the right due to changes in C, I, G, and X.

  • An increase in real wealth: greater wealth increases the demand for all goods.
  • Increased optimism about the future: both current consumption and investment increase.
  • High capacity utilization: companies have to increase investment spending to expand production.
  • Expanding fiscal policy: higher government spending and lower taxes will increase G and C.
  • An increase in money supply: higher income and expenditure.
  • A lower interest rate - when borrowing is cheaper, investment increases; consumption is cheaper with a lower interest rate.
  • A decrease in exchange rate: increases export demand.
  • Growth in the global economy: increases export demand.

And vice versa.

Factors that Shift Aggregate Supply

We need to differentiate between the long-run and short-run effects.

Increases in short-run aggregate supply (SRAS) that don't affect long-run aggregate supply are caused by:

  • A decrease in resource prices/production costs (e.g., nominal wages, input prices). Unless the lower prices of resources reflect a long-term increase in the supply of resources, they will not alter LRAS.
  • A reduction in the expected rate of inflation. If high inflation is expected, suppliers would like to reduce supplies now to sell them at higher prices later but consumers would like to spend more money now.
  • Lower business taxes and higher government subsidies.
  • Favorable exchange rates for importers of raw materials.

And vice versa.

Long-run supply refers to the economy's long-run production possibilities (maximum rate of sustainable output). Increase in long-run aggregate supply (LRAS) is caused by:

  • An increase in the supply of resources. This will expand the economy's sustainable rate of output. Note that an economy's resource base includes physical capital, natural resources and human capital.
  • An improvement in technology and productivity. This will increase the average output per unit of resources.

And vice versa.

User Contributed Comments 3

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allodrfc: When they say 'vice versa' above. Do they mean the opposite will have the same cause i.e. shift to the right? Or it will shift to the left?
oneashok: shift to left...
cmacewen: A reduction in the expectation of inflation rates will not shift the supply curve to the right.