Panel (a) of Figure 13.16, “From Aggregate Expenditures to Aggregate Demand” shows three possible aggregate expenditures curves for three different price levels. For example, the aggregate expenditures curve labeled AE_P=1.0 is the aggregate expenditures curve for an economy with a price level of 1.0. Since that aggregate expenditures curve crosses the 45-degree line at $6,000 billion, equilibrium real GDP is $6,000 billion at that price level. At a lower price level, aggregate expenditures would rise because of the wealth effect, the interest rate effect, and the international trade effect. Assume that at every level of real GDP, a reduction in the price level to 0.5 would boost aggregate expenditures by $2,000 billion to AE_{P = 0.5}, and an increase in the price level from 1.0 to 1.5 would reduce aggregate expenditures by $2,000 billion. The aggregate expenditures curve for a price level of 1.5 is shown as AE_P=1.5. There is a different aggregate expenditures curve, and a different level of equilibrium real GDP, for each of these three price levels. A price level of 1.5 produces equilibrium at point A, a price level of 1.0 does so at point B, and a price level of 0.5 does so at point C. More generally, there will be a different level of equilibrium real GDP for every price level; the higher the price level, the lower the equilibrium value of real GDP.

Figure 13.16. From Aggregate Expenditures to Aggregate Demand

Because there is a different aggregate expenditures curve for each price level, there is a different equilibrium real GDP for each price level. Panel (a) shows aggregate expenditures curves for three different price levels. Panel (b) shows that the aggregate demand curve, which shows the quantity of goods and services demanded at each price level, can thus be derived from the aggregate expenditures model. The aggregate expenditures curve for a price level of 1.0, for example, intersects the 45-degree line in Panel (a) at point B, producing an equilibrium real GDP of $6,000 billion. We can thus plot point B′ on the aggregate demand curve in Panel (b), which shows that at a price level of 1.0, a real GDP of $6,000 billion is demanded.

Panel (b) of Figure 13.16, “From Aggregate Expenditures to Aggregate Demand” shows how an aggregate demand curve can be derived from the aggregate expenditures curves for different price levels. The equilibrium real GDP associated with each price level in the aggregate expenditures model is plotted as a point showing the price level and the quantity of goods and services demanded (measured as real GDP). At a price level of 1.0, for example, the equilibrium level of real GDP in the aggregate expenditures model in Panel (a) is $6,000 billion at point B. That means $6,000 billion worth of goods and services is demanded; point B′ on the aggregate demand curve in Panel (b) corresponds to a real GDP demanded of $6,000 billion and a price level of 1.0. At a price level of 0.5 the equilibrium GDP demanded is $10,000 billion at point C′, and at a price level of 1.5 the equilibrium real GDP demanded is $2,000 billion at point A′. The aggregate demand curve thus shows the equilibrium real GDP from the aggregate expenditures model at each price level.

Consider the aggregate expenditures curves given in Panel (a) of Figure 13.17, “Changes in Aggregate Demand”, each of which corresponds to a particular price level. Suppose net exports rise by $1,000 billion. Such a change increases aggregate expenditures at each price level by $1,000 billion.

A $1,000-billion increase in net exports shifts each of the aggregate expenditures curves up by $1,000 billion, to AE′_P=1.0 and AE′_P=1.5. That changes the equilibrium real GDP associated with each price level; it thus shifts the aggregate demand curve to AD₂ in Panel (b). In the aggregate expenditures model, equilibrium real GDP changes by an amount equal to the initial change in autonomous aggregate expenditures times the multiplier, so the aggregate demand curve shifts by the same amount. In this example, we assume the multiplier is 2. The aggregate demand curve thus shifts to the right by $2,000 billion, two times the $1,000-billion change in autonomous aggregate expenditures.

Figure 13.17. Changes in Aggregate Demand

The aggregate expenditures curves for price levels of 1.0 and 1.5 are the same as in Figure 13.16, “From Aggregate Expenditures to Aggregate Demand”, as is the aggregate demand curve. Now suppose a $1,000-billion increase in net exports shifts each of the aggregate expenditures curves up; AE_P=1.0, for example, rises to AE′_P=1.0. The aggregate demand curve thus shifts to the right by $2,000 billion, the change in aggregate expenditures times the multiplier, assumed to be 2 in this example.

In general, any change in autonomous aggregate expenditures shifts the aggregate demand curve. The amount of the shift is always equal to the change in autonomous aggregate expenditures times the multiplier. An increase in autonomous aggregate expenditures shifts the aggregate demand curve to the right; a reduction shifts it to the left.

Case in Point: Predicting the Impact of Alternative Fiscal Policies in 2008

Figure 13.18. 

Economists are often asked to simulate the effects of policy changes on the economy. In 2008, as the economy weakened and Congress and the president debated a stimulus package, Mark M. Zandi, an economist at Moody’s Economy.com, produced a paper assessing the impact of various possible stimulus packages. His research produced the following table.

Table 13.2. Fiscal Economic Bang for the Buck

Tax cuts
Nonrefundable lump-sum tax rebate	1.02
Refundable lump-sum tax rebate	1.26
Temporary tax cuts
Payroll tax holiday	1.29
Across-the-board tax cut	1.03
Accelerated depreciation	0.27
Permanent tax cuts
Extend alternative minimum tax patch	0.48
Make Bush income tax cuts permanent	0.29
Make dividend and capital gains tax cuts permanent	0.37
Spending increases
Extending UI benefits	1.64
Temporary increase in food stamps	1.73
General aid to state governments	1.36
Increased infrastructure spending	1.59

One year $ change in real GDP for a given $ reduction in federal tax revenue or increase in spending

The $100-billion tax rebate for households that was actually passed was of the nonrefundable lump-sum type. “Nonrefundable” refers to the fact those not earning enough to pay income taxes would not receive a rebate, meaning that many households received zero or partial refunds. As shown, he estimated that a $100-billion tax rebate would shift the aggregate demand curve by $102 billion, assuming a constant price level. As part of the analysis, in the article he mentioned that he assumed an MPC of about two-thirds, since many households at the time were living paycheck-to-paycheck. So, consumption would increase by about $67 billion. The implied multiplier is thus 1.54 (= 102/67).

The table shows that other stimuli would have smaller or larger effects. He reasoned that making various tax cuts permanent would have little impact on consumption now, since households in 2008 were cash-strapped. The table shows an estimated bigger bang for the buck from various kinds of government spending increases. That follows, since the change in aggregate expenditure is the full amount of the spending increase instead of the portion of a tax rebate of the same magnitude that consumers decide to spend.

Answer to Try It! Problem

The lowest price level, P₁, corresponds to the highest AE curve, AE_{P = P1}, as shown. This suggests a downward-sloping aggregate demand curve. Points A, B, and C on the AE curve correspond to points A′, B′, and C′ on the AD curve, respectively.

Figure 13.19.