Aggregate demand (AD) is the total amount of real GDP that households, firms, the government, and foreign buyers want to buy at each price level: AD = C + I + G + Xn. A change in the price level moves the economy along AD, while a change in anything else that affects spending shifts the whole curve. Use the lab to try both and see which part of spending changes.
The economy starts at a price level of 100 with 1,000 billion of real GDP demanded (point A on AD₀). Move the price level slider to slide along the curve, or pick a scenario to shift it. Dashed grey shows the starting position.
Aggregate demand is the quantity of real GDP that all buyers in the economy plan to purchase at each price level. It adds up consumption (C), investment (I), government spending (G), and net exports (Xn = exports − imports).
When the price level rises: the wealth effect lowers the purchasing power of household wealth, so C falls; the interest rate effect raises money demand and interest rates, so I falls; the exchange rate (foreign purchases) effect makes domestic goods more expensive than foreign goods, so Xn falls.
The price level is on the vertical axis, so a change in the price level moves the economy along the existing AD curve. That is a change in the quantity of real GDP demanded, not a change in AD.
Anything other than the price level that changes C, I, G, or Xn shifts AD. More spending at every price level shifts AD right. Less spending at every price level shifts AD left.
If interest rates rise because the price level rose, that is the interest rate effect: a movement along AD. If interest rates rise for another reason, such as a central bank action, investment falls at every price level and AD shifts left.
A first change in spending creates income for others, who then spend part of it. So the final shift in AD is larger than the first change. This lab draws the shift equal to the first change to keep the numbers simple.
For each event, name the component of spending first, then the direction of the AD shift. That two-step chain is what FRQ graders look for.
| Event | Component | Why | Effect on AD |
|---|---|---|---|
| Price level rises | C, I, and Xn | Wealth, interest rate, and exchange rate effects | Movement up along AD (no shift) |
| Price level falls | C, I, and Xn | The same three effects in reverse | Movement down along AD (no shift) |
| Consumer confidence rises | C ↑ | Households expect higher future income | Right |
| Stock or home prices fall (household wealth falls) | C ↓ | Households feel poorer and spend less | Left |
| Household debt rises sharply | C ↓ | More income goes to debt payments | Left |
| Personal income taxes cut (or transfers rise) | C ↑ | Disposable income rises | Right |
| Business expectations improve | I ↑ | Firms expect higher future sales and profits | Right |
| Interest rates rise (not caused by the price level) | I ↓ | Borrowing for new capital costs more | Left |
| Business taxes cut or investment tax credit | I ↑ | Investment becomes more profitable | Right |
| Government spending increases | G ↑ | Government buys more goods and services | Right |
| Incomes abroad rise | Xn ↑ | Foreigners buy more of our exports | Right |
| Domestic currency appreciates | Xn ↓ | Exports cost more abroad; imports cost less here | Left |
| Domestic currency depreciates | Xn ↑ | Exports cost less abroad; imports cost more here | Right |
AP-style multiple choice. Pick an answer to see the explanation.
The vocabulary for topic 3.1. Read the list, flip through flashcards, or quiz yourself. For every term in the unit, see the Unit 3 terminology guide.