Question

Which of the following will cause a leftward shift in the aggregate demand​ curve?

A.

a reduction in the money supply

B.

an increase in taxes

C.

a reduction in government spending

D.

all of the above

Answer 1

Aggregate demand (AD) curve :- It is a locus of points of total goods and services demanded in the economy at various price levels prevailing in the economy. It is a downward sloping curve.

Leftward Shift of AD curve :- When the total goods and services demanded in the economy falls at certain given price level then the aggregate demand as a whole falls and shifts leftwards. It usually happens when the economy is in contracting phase.

Equation of AD curve in an open economy :-

c = Marginal propensity to consume

Y = Output level or GDP

(Y-T) = Disposable Income as T is Taxation

I(r) = Investment as a function of interest rate

G = Government spending

NX(e) = Net exports as a function of exchange rate.

So a decrease in any one of the these parameters will shift the AD curve leftwards, as Y (output) decreases.

Now Coming to the question-

a) Reduction in money supply

A reduction in money supply causes a decrease in the value of nominal output and hence a decrease in output or GDP 'Y'. Also a reduction in money supply causes a rise in interest rates and therefore affects the consumer spending and hence also reduces the Output or GDP 'Y'.

Therefore, Reduction in money supply cause a fall in output and hence a leftward shift in AD curve.

b) An increase in Taxes

An increase in taxation will reduce the disposable income available to the consumer and hence will reduce his spending. It is evident from the AD equation as well that a fall in Disposable income will reduce the output or GDP 'Y'.

Therefore, An increase in tax reduces the disposable income and hence the fall in output and a leftward shift in AD curve.

c) A reduction in government spending

A reduction in government spending (G) will reduce the output or GDP (Y) as evident from the AD curve equation. A fall in G will lead to an overall fall in the output level Y.

Therefore, A reduction in government spending will reduce the output and hence a leftward shift in the aggregate demand curve

d) All the Above

As all the options above i.e. a, b, c causes the AD curve to shift leftwards.

Hence, Option D) All the above is the correct option.