Shifts in Aggregate Demand

Self-Check Questions

How would a dramatic increase in the value of the stock market shift the AD curve? What effect would the shift have on the equilibrium level of GDP and the price level?

Hint:

An increase in the value of the stock market would make individuals feel wealthier and thus more confident about their economic situation. This would likely cause an increase in consumer confidence leading to an increase in consumer spending, shifting the AD curve to the right. The result would be an increase in the equilibrium level of GDP and an increase in the price level.

Suppose Mexico, one of our largest trading partners and purchaser of a large quantity of our exports, goes into a recession. Use the AD/AS model to determine the likely impact on our equilibrium GDP and price level.

Hint:

Since imports depend on GDP, if Mexico goes into recession, its GDP declines and so do its imports. This decline in our exports can be shown as a leftward shift in AD, leading to a decrease in our GDP and price level.

A policymaker claims that tax cuts led the economy out of a recession. Can we use the AD/AS diagram to show this?

Hint:

Tax cuts increase consumer and investment spending, depending on where the tax cuts are targeted. This would shift AD to the right, so if the tax cuts occurred when the economy was in recession (and GDP was less than potential), the tax cuts would increase GDP and “lead the economy out of recession.”

Many financial analysts and economists eagerly await the press releases for the reports on the home price index and consumer confidence index. What would be the effects of a negative report on both of these? What about a positive report?

Hint:

A negative report on home prices would make consumers feel like the value of their homes, which for most Americans is a major portion of their wealth, has declined. A negative report on consumer confidence would make consumers feel pessimistic about the future. Both of these would likely reduce consumer spending, shifting AD to the left, reducing GDP and the price level. A positive report on the home price index or consumer confidence would do the opposite.