Macroeconomics For Dummies®, uk edition Published by: John Wiley & Sons, Ltd

Observing movement along the AD curve

A movement along the AD curve represents the change in aggregate demand caused only by a change in the price level. You assume that everything else remains as it was (called the ceteris paribus assumption, fact fans – Latin for ‘all other things equal’).

Figure 7-5 shows that at the price level P₁, aggregate demand is equal to Y₁. If the price level falls to P₂ – so that on average things are cheaper – aggregate demand increases from Y₁ to Y₂ due to the three effects outlined in the preceding section. Assuming that everything else remains as it was means that this increase in aggregate demand can be attributed just to the fall in the price level (and the direct effect this fall has on other variables in the economy).


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Figure 7-5: Movement along the AD curve: at price level P₁, aggregate demand is equal to Y₁; at price level P₂, aggregate demand is equal to Y₂.

Similarly, if the price level were to rise from P₂ to P₁, the AD curve tells you that aggregate demand will fall from Y₂ to Y₁.

Tracing a shift of the curve

Anything that causes aggregate demand to change other than the price level leads to a shift of the AD curve.

In Figure 7-6, aggregate demand has increased from AD₁ to AD₂, which means that at any given price level, aggregate demand is now greater. For example, at the price level P₁, aggregate demand used to be equal to Y₁. After the shift of the AD curve, aggregate demand would equal Y₂ if the price level were to remain at P₁.

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Figure 7-6: A shift of the AD curve.


Many things can cause the AD curve to shift in this way, including the following:


Increased consumer confidence: At any given price level, households want to consume more (an increase in C).


Increased confidence of firms: At any given price level, firms want to invest more (an increase in I).


Increase in government purchases: Perhaps the government decides that it wants to spend more on healthcare (an increase in G).

Increase in demand for exports: Caused by a fall in the value of the

pound (an increase in NX).


Lower taxes: Encourages spending by households and firms (an increase in C and I).


Increase in the money supply reduces the interest rate: Stimulates spending by households and firms (an increase in C and I).

Clearly, all these factors also work in the opposite direction so that a fall in consumer confidence or a fall in government expenditure leads to a decrease in aggregate demand, which shifts the AD curve to the left (see Figure 7-7).

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Figure 7-7: A fall in aggregate demand.

Chapter 8