• 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

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.