How does an increase in net exports shift the AD curve?

Aggregate demand (AD) is the total demand for an economy’s output at a given price level. It has four components:

• Consumption (C): household spending on goods and services.
• Investment (I): business spending on capital goods and raw materials.
• Government spending (G): government purchases of goods and services (not transfers).
• Net exports (NX): the value of exports (X) minus the value of imports (M).

When any of these components increase, ceteris paribus, AD increases, shown by a rightward shift of the AD curve.

For C, I, G, and exports, the relationship is straightforward: more spending on domestic output means higher AD. But it is less obvious why a fall in imports raises AD.

Consider this example: If German households buy 5 German cars and 1 Japanese car, German output is 5 cars. Yet firms report sales as 6 cars, so consumption is recorded as the value of 6 cars. To avoid overstating domestic output, the value of the imported car is subtracted. In effect, imports are deducted from C, I, and G to ensure AD reflects demand for domestic production only.

This is especially important with imported inputs. If a $\text{\textdollar}$100 belt is recorded as consumption but $\text{\textdollar}$20 of materials were imported, subtracting imports ensures AD reflects the $\text{\textdollar}$80 of domestic value added.

Returning to the car example: if next year total car sales stay at 6 but imports fall to zero, consumption is unchanged, but domestic production must have risen from 5 to 6. In this case, households are substituting a domestically produced car for the previously imported one. Thus, lower imports—holding other components constant—mean greater demand for domestic output.

In short:

• If exports increase, foreign demand for domestic goods rises → AD increases.

• If imports decrease (without a fall in C, I, or G), households or firms must be substituting toward domestic goods → AD increases.

Therefore, when net exports increase—whether from higher exports or lower imports—aggregate demand increases, and the AD curve shifts to the right.