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

Delving into Demand-Side Shocks

Demand-side shocks are anything that impacts on aggregate demand. So anything that affects consumption (C), investment (I) or net exports (NX) would count as a demand-side shock. So too would a change in government expenditure (G). Demand-side shocks are important because they have an impact on real GDP, inflation and unemployment (as least in the short run).

We cover how changes in confidence, investment, fiscal and monetary policies, and the multiplier effect can change the level of aggregate demand. All of these have a different impact on the economy depending on whether you’re looking at the short run or the long run. Be sure to bear that in mind when looking at each one.

Testing your faith: Confidence in the economy

In life, confidence matters. It can mean the difference between landing your dream job and not, winning that crucial business contract and not, or between

coming first in the race and coming second. Similarly, consumer and firm confidence can have a large impact on the economy, in the short and the long run (sometimes in surprising ways).

Changes in consumer confidence directly impact on consumers’ spending decisions. While watching news stories about the economy, you may hear how boosting consumer confidence is a ‘good thing’ for the economy. Although often true in the short run, over longer periods it’s not necessarily the case.

John Maynard Keynes, one of the fathers of macroeconomics, attributed much of human behaviour to what he called their animal spirits. That is, sometimes people are just more confident about the future than at other times, and it doesn’t have to be for any discernible reason. This makes understanding the economy more difficult for economists but also more interesting!

In this section we use the AD–AS model to show you how changes in consumer and firm confidence impact the economy.