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There is a positive correlation between the aggregate demand and the changes in monetary policy. ‘If the government wants to increase the quantity or the supply of money in its economy then it undertakes an “expansionary monetary” policy and similarly if it wants to reduce the quantity of money in the economy it adapts a “contractionary monetary policy. (Case &amp. Fair, 2002)”‘3 This means that if the quantity of money increases in the economy then the aggregate demand shifts outwards or to the right, i.e. more output is demanded at the same price. Conversely, if the supply of money shrinks in the economy then the aggregate demand shifts inward or to the left as a result of a decrease in demand of output at all the various levels of price in the economy. Graphically it can be as follows:

‘Case &amp. Fair (2002) explain that when the quantity of money increases in the economy then the interest rates fall due to which the cost of carrying out planned investment decreases and therefore there is higher investment expenditure. This in turn increases the output at each price level and the opposite happens when the quantity of money decreases in the economy.’4

The government also demands the output in terms of goods and services. …

‘If the government wants to increase the quantity or the supply of money in its economy then it undertakes an “expansionary monetary” policy and similarly if it wants to reduce the quantity of money in the economy it adapts a “contractionary monetary policy. (Case &amp. Fair, 2002)”‘3 This means that if the quantity of money increases in the economy then the aggregate demand shifts outwards or to the right, i.e. more output is demanded at the same price. Conversely, if the supply of money shrinks in the economy then the aggregate demand shifts inward or to the left as a result of a decrease in demand of output at all the various levels of price in the economy. Graphically it can be as follows:

‘Case &amp. Fair (2002) explain that when the quantity of money increases in the economy then the interest rates fall due to which the cost of carrying out planned investment decreases and therefore there is higher investment expenditure. This in turn increases the output at each price level and the opposite happens when the quantity of money decreases in the economy.’4

Therefore, the changes in the AD can be summed up as follows according to the changes in the quantity of money:

Increase in the supply of money – Aggregate Demand shifts to its ‘right.’

Decrease in the supply of money – Aggregate Demand shifts to its ‘left.’

3. Fiscal Policy

Fiscal policy includes two components:

Government spending and expenditure.

Changes in the taxation policy by the government.

3.1 Government spending and expenditure

The government also demands the output in terms of goods and services. Therefore, a change in the government spending or purchases influences the aggregate demand.

 
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