Aggregate Demand

1. Aggregate Demand Shifts and the Multiplier Effect

2. The Aggregate Demand CurveQuestion 2 page 239 Price Level Diagram for illustrating answers P AD2 AD1 AD3 Output Y3 Y Y1 Y2

3. The Aggregate Demand Curve (a) The increase in real investment expenditure between 2000 and 2005 will have led to an increase in aggregate expenditure and therefore aggregate output. The AD curve will have shifted to the right, from AD1 to AD2. Price Level P AD2 AD1 AD3 Output Y3 Y Y1 Y2

4. The Aggregate Demand Curve (b) The large rise in interest rates between May 1987 and October 1989 will have led to a fall in both consumption and investment spending. This will have led to a fall in aggregate demand by a shift to the left in AD curve from AD1 to AD3. Price Level P AD2 AD1 AD3 Output Y3 Y Y1 Y2

5. The Aggregate Demand Curve (C) The large cuts in taxes of the 1987 Budget will have led to an increase in consumption expenditure as households’ disposable income rose. This in turn will have led to an increase in aggregate expenditure and therefore output. The AD curve will then have shifted to the right, from AD1 to AD2. P Price Level AD2 AD1 AD3 Output Y3 Y Y1 Y2

6. The Aggregate Demand Curve (d) The 50% fall in stock market prices between December 1999 and January 2003 led to a substantial fall in wealth for a minority of individuals and businesses. This will have led to a fall in consumption, shifting the AD curve to the left from AD1 to AD3. Price Level P AD2 AD1 AD3 Output Y3 Y Y1 Y2

7. The Aggregate Demand Curve (e) The fall in the savings ratio between 1992 and 2004 will have been mirrored by a rise in the consumption ratio. AD and output will have risen. Hence the AD curve will have shifted to the right, from AD1 to AD2. Price Level P AD2 AD1 AD3 Output Y3 Y Y1 Y2

8. The Aggregate Demand Curve (f) The increase in planned public expenditure between 2000 and 2007 on education and health care will have led to a rise in aggregate expenditure and therefore aggregate output. The AD curve will therefore have shifted to the right, from AD1 to AD2. Price Level P AD2 AD1 AD3 Output Y3 Y Y1 Y2

9. The Aggregate Demand Curve (g) The high rise in the exchange rate will have led to a fall in exports and a rise in imports. This is because the UK became less competitive compared to its trading partners as a result of sterling’s appreciation. Lower exports and higher imports reduce AD. So, a shift in the left – from AD1 to AD3. Price Level P AD2 AD1 AD3 Output Y3 Y Y1 Y2

10. The multiplier and J Maynard Keynes • John Maynard Keynes is one the most important figures in the entire history of economics.  • He revolutionised economics with his classic book, The General Theory of Employment, Interest and Money(1936).  • This is seen as one of the most influential social science books of the 20th Century, in that it quickly and permanently changed the way the world looked at the economy and the role of government in society. 

11. The Multiplier • Keynes introduced the idea of the multiplier effect • He believed that every job created by extra spending would indirectly create other jobs • For example – the Government decides to build a new school in Harrow. What jobs might be created – both directly and indirectly? • However, for the multiplier effect to work as efficiently as Keynes hoped, leakages – money that is not spent – need to be kept to a minimum

12. Activities (p.239/240) • Copy figure 3 on page 239. • Read ‘The Multiplier’ (p.239-40). • Explain, stage by stage, what the diagram on p.239 shows (you may want to add extra labels). • How do leakages affect the multiplier’s value? • During 2009, the Labour Government tried to increase national income by increasing government spending. Suggest reasons why this didn’t work as well as they hoped.