# AD and Circular Flow of Income

1. How can you show an AD shift left or right, using the circular flow? The conflict in my understanding is W MUST equal J because of identities etc. Yet AD can only move if W>J or J>W. I thought that if that happened, that is macroeconomic disequilibrium. Not a shift. is it disequilibrium (excess supply or demand), that leads to a shift? (like market forces and ordinary D&S diagrams?)

AD = C + I + G + X – M (total demand in the economy)

Keynesian Model

In the Keynesian model we refer to Aggregate Expenditure (E) A different term to the AD / AS model

AD = E = Cd + J

Here J(injections) equals investment (I), Government Spending (G) and Exports (X)

It is true that in Equilibrium J = W injections equal withdrawals.

If there is an increase in injections into the economy. There will be a rise in E (Total Expenditure = AD) causing a rise in National Income.

This means that there will be disequilibrium because J is now greater than W. However, as National Income rises there will also be a rise in withdrawals (W) people save more, pay more tax and spend more on imports

Therefore, W will rise until it equals J. However, now the level of AD=E is higher, also there is an increase in National Income

To put some numbers in to clarify, imagine 200 is going round the circular flow. An extra 30 is injected, therefore an extra 30 is withdrawn. Total flowing round is now 230. Does AD move right or what?

Yes, AD (or E as it called in the Keynesian model) will shift to the right. Initially J is greater than W causing rise in AD.

(Note in the Keynesian 45 degree model the AD curve shifts upwards, which is effectively the same as shifting to the right.)