March 21, 2018 

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ABSOLUTE ADVANTAGE: The general ability to produced more goods using fewer resources. This idea of absolute advantage is important for trading that occurs between both people and nations. A nation can get an absolute advantage from an advanced level of technology or higher quality resources. For a person, an absolute advantage can result from natural abilities or the acquisition of human capital (education, training, or experience).

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A shock to the long-run aggregate market caused by a decrease in aggregate demand resulting in and illustrated by a leftward shift of the aggregate demand curve. A decrease in aggregate demand in the long-run aggregate market results in an increase in the price level but no change in real production. The level of real production resulting from the aggregate demand shock is full-employment real production.
While a wide range of specific aggregate demand determinants can cause a decrease in the four expenditures and thus a decrease in aggregate demand, the following rank among the more important:
  • A decrease in consumer confidence brought on by concerns that the economy might be headed for troubled times, which then prompt the household sector to spend a smaller proportion of disposable income on consumption.

  • Expectations of lower inflation rates in the near future that entices the household sector to decrease consumption expenditures in the present awaiting lower future prices.

  • A rise in interest rates associated with natural business-cycle activity or specifically induced by contractionary monetary policy from the Federal Reserve System that induces the household and business sectors to decrease consumption and investment expenditures.

  • Contractions in other nations that induce the foreign sector to decrease the purchase of domestic exports, thus decreasing net exports.

  • A decrease in purchases and/or an increase taxes by the federal government resulting from contractionary fiscal policy.

  • A decrease in state or local government purchases, and/or an increase in state or local taxes.
Demand Decrease
Long-Run Aggregate Market
Long-Run Aggregate Market
The long-run aggregate market presented in the graph to the right sets the stage for analyzing the effect of a decrease in aggregate demand resulting from a change in an aggregate demand determinant. The vertical axis measures the price level (GDP price deflator) and the horizontal axis measures real production (real GDP). The negatively-sloped curve, labeled AD, is the aggregate demand curve and the vertical curve, labeled LRAS, is the long-run aggregate supply curve. The current long-run equilibrium, found at the intersection of the AD and LRAS curves, is a price level of 10 and real production of $100 billion. This equilibrium level of real production is also full-employment real production.

Consider what happens to this long-run aggregate market with a decrease in aggregate demand. Suppose, for example, that after several years of business-cycle expansion, the household sector grows increasingly concerned that a contraction is on the horizon. Suspecting that a contraction is about to begin, they spend less and save more, preparing for the troubled times ahead. This decline in consumer confidence prompts the household sector to decrease consumption expenditures. The result of this action is a leftward shift of the AD curve. Click the [AD Decrease] button to illustrate.

The result of this leftward AD curve shift is that a new long-run equilibrium is achieved at a lower price level (9) BUT THE SAME amount of real production ($100 billion). This result is similar to that for a standard market, with one small difference. A decrease in market demand results in a lower equilibrium price and a SMALLER equilibrium quantity. The small difference is that the "quantity" in the aggregate market DOES NOT CHANGE. The original equilibrium and the new equilibrium levels of real production are both full-employment real production.

A comparative static analysis of the original equilibrium and the new equilibrium is useful and important. However, it is also instructive to dissect the adjustment process.

  • First, the AD curve shifts leftward due to the decrease in consumption induced by a decline in consumer confidence. This decline in aggregate demand creates an imbalance in the aggregate market. At the existing price level (which has NOT yet changed), producers are willing and able to sell $100 billion worth of real production. Buyers, however, are now willing and able to purchase more, something like $80 billion worth of real production. This creates economy-wide product market surpluses.

  • Second, motivated by a build-up of inventories created by economy-wide product market surpluses, producers try to decrease production. In the short run they can do so by reducing the employment of resources, especially labor. In the long run, however, wage and resource price flexibility ensures that any imbalances in the resource markets are eliminated. Resource markets remain in equilibrium, meaning full-employment production is supplied. The only long-run result of attempts by producers to decrease production is a falling price level.

  • Third, with the falling price level, buyers are induced to increase aggregate expenditures. The increase in aggregate expenditures acts to reduce the economy-wide product market surpluses. In fact, as long as economy-wide product market surpluses persist, the price level falls and aggregate expenditures rise. This continues until aggregate expenditures exactly match the full-employment level of production. The end result is a new long-run equilibrium price level of 8 and the original full-employment real production of $100 billion.


Recommended Citation:

AGGREGATE DEMAND DECREASE, LONG-RUN AGGREGATE MARKET, AmosWEB Encyclonomic WEB*pedia,, AmosWEB LLC, 2000-2018. [Accessed: March 21, 2018].

Check Out These Related Terms...

     | aggregate market shocks | aggregate demand increase, long-run aggregate market | aggregate supply increase, long-run aggregate market | aggregate supply decrease, long-run aggregate market | aggregate demand increase, short-run aggregate market | aggregate demand decrease, short-run aggregate market | aggregate supply increase, short-run aggregate market | aggregate supply decrease, short-run aggregate market |

Or For A Little Background...

     | aggregate market | aggregate market analysis | long-run aggregate market | equilibrium, aggregate market | equilibrium, long-run aggregate market | aggregate demand | aggregate supply | aggregate expenditures | long-run aggregate supply | aggregate demand curve | long-run aggregate supply curve | price level | GDP price deflator | real gross domestic product | market adjustment | demand shock |

And For Further Study...

     | disequilibrium, aggregate market | disequilibrium, long-run aggregate market | output gaps | self correction, aggregate market | self correction, recessionary gap | self correction, inflationary gap | Keynesian economics | monetary economics | classical economics |

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