International Finance Theory and Policy
by Steven M. Suranovic
Finance 602

Shifting the DDCurveT he DDcurve depicts the relationship between changes in one exogenous variable and one endogenous variable within the G&S market model. The exogenous variable assumed to change is the exchange rate. The endogenous variable affected is GNP. At all points along the DDcurve it is assumed that all other exogenous variables remain fixed at their original values. The DDcurve will shift, however, if there is a change in any of the other exogenous variables.We illustrate how this works in the adjoining diagram. Here we assume that the level of investment demand in the economy falls from its initial level I_{1} to a lower level I_{2}. At the initial investment level, I_{1}, and initial exchange rate, E_{$/£}^{1}, the AD curve is given by AD( , E_{$/£}^{1}, I_{1}, .. ).The AD curve intersects the 45Ίline at point G, which is transferred to point G on the DD curve below.If the investment level, and all other exogenous variables remain fixed while the exchange rate increases to E_{$/£}^{2} then the AD curve shifts up to AD( , E_{$/£}^{2}, I_{1}, ) generating the equilibrium points H in both diagrams.This exercise plots out the initial DD curve labeled DD_{I1} in the lower diagram connecting points G and H. DD_{I1} is read as the DD curve given that I = I_{1}. Now, suppose I falls to I_{2}. The reduction in I leads to a reduction in AD, ceteris paribus. At the exchange rate E_{$/£}^{1}, the AD curve will shift down to AD( , E_{$/£}^{1}, I_{2}, ) intersecting the 45Ίline at point K. Point K above, which corresponds to the combination (E_{$/£}^{1}, I_{2}), is transferred to point K on the lower diagram. This point lies on a new DDcurve because a second exogenous variable, namely I, has changed. If we maintain the investment level at I_{2} and change the exchange rate up to E_{$/£}^{2} the equilibrium will shift to point L (shown only on the lower diagram), plotting out a whole new DDcurve. This DDcurve is labeled DD_{I2} which means the DD curve given that I = I_{2}. The effect of a decrease in investment demand is to lower aggregate demand and shift the DDcurve to the left.Indeed, a change in any exogenous variable that reduces aggregate demand, with the exception of the exchange rate, will cause the DD curve to shift to the left. Likewise, any change in an exogenous variable that causes an increase in aggregate demand will cause the DDcurve to shift right. An exchange rate change WILL NOT shift DD because its effect is accounted for by the DDcurve itself. [NB: Curves/lines can shift only when a variable NOT plotted on the axis changes] The following table presents a list of all variables that can shift the DDcurve right and left. The uparrow indicates an increase in the variable, a downarrow a decrease.
Refer back to Chapter 50 for a complete description of how and why each variable affects aggregate demand. For easy reference though, recall that G is government demand, I is investment demand, T refers to tax revenues, TR is government transfer payments, P_{$} is the US price level and P_{£} is the foreign British price level. International Finance Theory and Policy  Chapter 602: Last Updated on 1/23/05 