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FLEXIBLE PRICES: The proposition that prices adjust in the long run in response to market shortages or surpluses. This condition is most important for long-run macroeconomic activity and long-run aggregate market analysis. In particular, flexible prices are the key reason for the vertical slope of the long-run aggregate supply curve. This proposition is also central to original classical theory of macroeconomics and to modern variations, including rational expectations, new classical theory, and supply-side economics.

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FEDERAL DEFICIT, AGGREGATE DEMAND DETERMINANT:

One of several specific aggregate demand determinants assumed constant when the aggregate demand curve is constructed, and that shifts the aggregate demand curve when it changes. An increase in the federal deficit causes an increase (rightward shift) of the aggregate curve. A decrease in the federal deficit causes a decrease (leftward shift) of the aggregate curve. Other notable aggregate demand determinants are interest rates, inflationary expectations, and the money supply.
The federal deficit is the excess of federal government spending over tax collections. The flip side of the federal deficit is the less common federal surplus, the excess of tax collections over spending. A key aspect of the expenditures part of the federal deficit is government purchases, which are the one of the four aggregate expenditures that make up aggregate demand. The other aspect of expenditures is transfer payments. Transfer payments add to household disposable income, the income that is used for consumption expenditures. The tax side of the federal deficit reduces disposable income that the household sector uses for consumption.

A change in the federal deficit, whether the result of government purchases, transfer payments, or taxes, induces changes in aggregate demand. A larger federal deficit increases aggregate demand and a smaller deficit decreases aggregate demand.

Shifting the Curve
Shifting the Curve

Consider a regular, run-of-the-mill aggregate demand curve such as the one displayed here. Like all aggregate demand curves, this one is constructed based on several ceteris paribus aggregate demand determinants, such as the size of the federal deficit. The key question is: What happens to the aggregate demand curve if the federal deficit changes?

A Bigger Federal Deficit

Suppose, for example, that Congress decides to boost a major spending program, such as a build-up of national defense, at the same time it implements a substantial reduction in income taxes. This simultaneous spending boost and tax reduction is just the sort of thing Congress is prone to do because it makes voters happy and keeps them in elected office. It might also be aimed at stimulating the economy out of a business-cycle contraction. The net result of these actions is an increase in the federal deficit.

The increase in government purchases used to build up national defense works directly to increase aggregate demand. This is reinforced by the tax reduction, which adds disposable income to the household sector. This extra income is used largely for consumption expenditures.

To see how a bigger federal deficit affects the aggregate demand curve, click the [Bigger Deficit] button. The greater deficit triggers an increase in aggregate demand, which is a rightward shift of the aggregate demand curve.

A Smaller Federal Deficit

Alternatively, Congress might decide that the federal deficit is too large and acts to trim it back by decreasing assorted expenditures are assorted programs, including education and highway construction, at the same income taxes are increased. These actions might also be aimed at fighting inflation associated with a business-cycle expansion. The net result is a decrease in the federal deficit.

The decrease in the government purchases used for education and highway construction works directly to decrease aggregate demand. This is reinforced by the tax increase, which reduces disposable income. The household sector responds to this income decrease, in part, by reducing consumption expenditures.

To see how a smaller federal deficit affects the aggregate demand curve, click the [Smaller Deficit] button. The smaller deficit generates a decrease in aggregate demand, which is a leftward shift of the aggregate demand curve.

What Does It Mean?

The importance of the federal deficit as an aggregate demand determinant is critical to the study of macroeconomics, especially fiscal policy designed to stabilize business cycles. A frequently recommended solution to business-cycle contractions is expansionary fiscal policy, consisting of increased government spending (government purchases or transfer payments) and/or decreased taxes. The net result of this policy action is to increase the federal deficit (or reduce a federal surplus if one should exist).

Alternatively, a solution to business-cycle expansions that are causing inflation is contractionary fiscal policy, consisting of decreased government spending (government purchases or transfer payments) and/or increased taxes. The net result of this policy action is to decrease the federal deficit (or increase a federal surplus if one should exist).

When these policies are implemented, the aggregate demand curve shifts, which then induces changes in production, unemployment, and the price level.

<= FEDERAL ADVISORY COUNCILFEDERAL DEFICIT, AGGREGATE EXPENDITURES DETERMINANT =>


Recommended Citation:

FEDERAL DEFICIT, AGGREGATE DEMAND DETERMINANT, AmosWEB Encyclonomic WEB*pedia, http://www.AmosWEB.com, AmosWEB LLC, 2000-2016. [Accessed: August 25, 2016].


Check Out These Related Terms...

     | aggregate demand determinants | interest rates, aggregate demand determinant | inflationary expectations, aggregate demand determinant | money supply, aggregate demand determinant | consumer confidence, aggregate demand determinant | exchange rates, aggregate demand determinant | physical wealth, aggregate demand determinant | financial wealth, aggregate demand determinant | change in aggregate demand | change in aggregate expenditures | aggregate demand shifts | slope, aggregate demand curve | aggregate supply determinants |


Or For A Little Background...

     | aggregate demand | aggregate expenditures | aggregate demand and market demand | determinants | gross domestic product | consumption expenditures | investment expenditures | government purchases | net exports | price level | real production | GDP price deflator | real gross domestic product | government functions |


And For Further Study...

     | AS-AD analysis | aggregate market | business cycles | circular flow | Keynesian economics | monetary economics | aggregate market shocks |


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