Aggregate Demand in Keynesian Analysis

What Determines Net Exports?

Recall that exports are domestically produced products that sell abroad while imports are foreign produced products that consumers purchase domestically. Since we define aggregate demand as spending on domestic goods and services, export expenditures add to AD, while import expenditures subtract from AD.

Two sets of factors can cause shifts in export and import demand: changes in relative growth rates between countries and changes in relative prices between countries. What is happening in the countries' economies that would be purchasing those exports heavily affects the level of demand for a nation's exports. For example, if major importers of American-made products like Canada, Japan, and Germany have recessions, exports of U.S. products to those countries are likely to decline. Conversely, the amount of income in the domestic economy directly affects the quantity of a nation's imports: more income will bring a higher level of imports.

Relative prices of goods in domestic and international markets can also affect exports and imports. If U.S. goods are relatively cheaper compared with goods made in other places, perhaps because a group of U.S. producers has mastered certain productivity breakthroughs, then U.S. exports are likely to rise. If U.S. goods become relatively more expensive, perhaps because a change in the exchange rate between the U.S. dollar and other currencies has pushed up the price of inputs to production in the United States, then exports from U.S. producers are likely to decline.

Table summarizes the reasons we have explained for changes in aggregate demand.

Reasons for a Decrease in Aggregate Demand Reasons for an Increase in Aggregate Demand
Consumption
  • Rise in taxes
  • Fall in income
  • Rise in interest rates
  • Desire to save more
  • Decrease in wealth
  • Fall in future expected income
Consumption
  • Decrease in taxes
  • Increase in income
  • Fall in interest rates
  • Desire to save less
  • Rise in wealth
  • Rise in future expected income
Investment
  • Fall in expected rate of return
  • Rise in interest rates
  • Drop in business confidence
Investment
  • Rise in expected rate of return
  • Drop in interest rates
  • Rise in business confidence
Government
  • Reduction in government spending
  • Increase in taxes
Government
  • Increase in government spending
  • Decrease in taxes
Net Exports
  • Decrease in foreign demand
  • Relative price increase of U.S. goods
Net Exports
  • Increase in foreign demand
  • Relative price drop of U.S. goods
Determinants of Aggregate Demand