With physical wealth the points is that once it has been acquired, it is no longer needed. That is, once Duncan Thurly owns a refrigerator, he has a refrigerator, and he does not need a refrigerator. Alternatively, not owning a refrigerator puts Duncan in prime position to buy a refrigerator. Changes in physical wealth, as such, tend to cause consumption expenditures to change in the opposite direction. If households have more physical wealth, then they do not need to buy what they have, and consumption tends to fall. If households have less physical wealth, then they do need to buy some, and consumption tends to rise.

A change in the physical wealth, by changing consumption expenditures, induces changes in aggregate demand. An increase in physical wealth decreases aggregate demand and a decrease in physical wealth increases aggregate demand.

Shifting the Curve

The exhibit to the right presents a common aggregate demand curve. Like all aggregate demand curves, this one is constructed based on several ceteris paribus aggregate demand determinants, such as physical wealth. The key question is: What happens to the aggregate demand curve if physical wealth changes?

More Physical Wealth

The household sector reduces consumption by increasing saving. This saving could take the form of simply diverting more disposable income into bank savings accounts or other financial assets. However, it is also likely to take the form of making payments on the loans used to purchase these durable goods. Because loan repayments are income that is NOT used to buy current production it is considering saving. The result is that this increase in physical wealth causes a decrease in consumption expenditures and subsequently a decrease in aggregate demand.

To see how an increase in physical wealth affects the aggregate demand curve, click the [More Wealth] button. The accumulation of physical wealth triggers a decrease in aggregate demand, which is a leftward shift of the aggregate demand curve.

Less Physical Wealth

The household sector is able to pay for this extra consumption, even though disposable income might not be rising, by decreasing saving. This saving could take the form of simply withdrawing funds from existing bank savings accounts or "cashing in" other financial assets. However, it is also likely to take the form of getting loans through financial markets. The result is that this decrease in physical wealth causes an increase in consumption expenditures and subsequently an increase in aggregate demand.

To see how a decrease in physical wealth affects the aggregate demand curve, click the [Less Wealth] button. The drop in physical wealth triggers an increase in aggregate demand, which is a rightward shift of the aggregate demand curve.

What Does It Mean?

During an expansion, the household sector accumulates physical wealth, especially in the form of durable goods. However, once this physical wealth has been accumulated, the household sector reduces consumption expenditures, often because they are paying off the debt used to buy these durable goods. The drop in consumption induces a decrease in aggregate demand, which can then trigger the onset of a contraction.