Answer to Question #277465 in Macroeconomics for Ali

Question

Define carefully the difference between movements along the AD curve and shifts of the AD curve. Explain why an increase in potential output would shift out the AS curve and lead to a movement along the AD curve. Explain why a tax cut would shift the AD curve outward (increase aggregate demand).  

Answer 1

Price level variations drive movement along these curves, whereas shifts in these curves occur when another variable (other than the price level) influences demand for products and services. The AD curve changes to the right when any of the aggregate demand components increases. The amount of production and the average price level rise when the AD curve changes to the right. As the AD rises, and the economy approaches potential output, the price will climb faster than the output. Individual tax cuts are likely to enhance consumption demand, whilst tax increases are likely to decrease it. Tax policy can also boost investment demand by lowering corporate tax rates or providing tax breaks for specific types of investment. Shifting C or I causes the AD curve to shift as a whole.