Aggregate Demand and the Multiplier

Aggregate demand (AD) is total planned spending in an economy at each price level. In IB Economics it is written as AD equals consumption plus investment plus government spending plus net exports.

What moves aggregate demand

Any change in one of the four components shifts the whole AD curve. A rise in consumer confidence raises consumption and shifts AD right. Higher interest rates reduce investment and shift AD left.

The multiplier

An injection into the economy does not stop at its first use. When the government spends, the money becomes income for others, who spend part of it again. This is the multiplier effect.

The size depends on the marginal propensity to consume. If households spend 0.8 of each extra unit of income, the multiplier is 1 divided by (1 minus 0.8), which equals 5. An HL answer shows this calculation.

The Paper approach

For a diagram, draw AD and AS, shift AD in the correct direction, and mark the change in real output and the price level. For the evaluation, weigh the effect against the state of the economy: near full capacity the same shift raises prices more than output.