Learning Objectives
By the end of this section, you will be able to do the following:- Explain how imports influence AD
- Identify ways in which business confidence and consumer confidence can affect AD
- Explain how government policy can change AD
- Evaluate why economists disagree on the topic of tax cuts
As mentioned previously, the components of AD are consumption spending (C), investment spending (I), government spending (G), and spending on exports (X) minus imports (M). Read the following Clear It Up feature for explanation of why imports are subtracted from exports and what this means for aggregate demand. A shift of the AD curve to the right means that at least one of these components increased so that a greater amount of total spending would occur at every price level. A shift of the AD curve to the left means that at least one of these components decreased so that a lesser amount of total spending would occur at every price level. The Keynesian Perspective will discuss the components of AD and the factors that affect them. Here, the discussion will sketch two broad categories that could cause AD curves to shift: changes in the behavior of consumers or firms and changes in government tax or spending policy.
Clear It Up
Do imports diminish aggregate demand?
We have seen that the formula for AD is AD = C + I + G + X – M, where M is the total value of imported goods. Why is there a minus sign in front of imports? Does this mean that more imports will result in a lower level of AD?
When an American buys a foreign product, for example, it gets counted along with all the other consumption. So the income generated does not go to American producers, but rather to producers in another country; it would be wrong to count this as part of domestic demand. Therefore, imports added in consumption are subtracted back out in the M term of the equation.
Because of the way in which the demand equation is written, it is easy to make the mistake of thinking that imports are bad for the economy. Just keep in mind that every negative number in the M term has a corresponding positive number in the C or I or G term, and they always cancel out.