Explain in detail how and why would the aggregate demand curve shift in response

Question

Explain in detail how and why would the aggregate demand curve shift in response to following changes:

a. An increase in personal taxes

b. An increase in expected profits and business confidence

c. A decrease in level of foreign GDP or real income

d. A decrease in nominal money supply by the Federal Reserve

e. Due to a war a law passes in Congress allowing drafting of all males and females between ages of 18 and 35.

f. A free immigration day is declared allowing 10 million immigrants passing the border within that day. All of them get the jobs of 10 million Americans in farming, leaving 10 million unemployed Americans

Explanation / Answer

(a)

An increase in personal taxes -

Increase in personal taxes will decrease the disposable income of households. Decrease in disposable income will compel the households to reduce their consumption.

Consumption is a component of aggregate demand.

So, this reduction in consumption will result in a decrease in aggregate demand.

Decrease in aggregate demand will shift the aggregate demand curve to the left.

(b)

An increase in expected profits and business confidence -

Increase in expected profits and business confidence will induce the businesses to invest more so that they would be able to expand their production and be able to take advantage of expected favorable economic conditions.

Investment is a component of aggregate demand.

So, this increase in investment by businesses will lead to increase in aggregate demand.

Increase in aggregate demand will shift the aggregate demand curve to the right.

(c)

A decrease in level of foreign GDP or real income

Decrease in level of foreign GDP or real income will compel the resident of foriegn country to consume less. So, they will import less goods and services as well.

This will result in fall in exports of home country.

Fall in exports will reduce the value of net exports (exports - imports).

Net exports is a component of aggregate demand.

So, this decrease in net exports will result in a decrease in aggregate demand.

Decrease in aggregate deamnd will shift the aggregate deamdn curve to the left.

(d)

A decrease in nominal money supply by the Federal Reserve

Given the deamnd for money, this decrease in nominal money supply will result in an increase in interest rates.

This increase in interest rates will raise the cost of borrowing and will compel the households and businesses to borrow less for consumption and investment spending.

Both investment and consumption will decrease.

Consumption and investment are component of aggregate demand.

So, this decrease in consumption and investment will result in a decrease in aggregate demand.

Decrease in aggregate demand will shift the aggregate deamnd curve to the left.

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