Aggregate Demand
AD = (estimate of) total demand for goods/services in an economy at a given price level
1. CONSUMPTION
2. INVESTMENT
3. GOVERNMENT SPENDING
4. NET EXPORTS (X – M)
AD = C + I + G + (X – M) (= Real GDP)
- AD shows the inverse relationship between Average Price Level & Real
Output
- Real GDP/Output >> adjusted for inflation
CONSUMPTION – C
- The demand of consumers
- Total spending by consumers/households on DOMESTIC goods and services produced inside
the economy/circular income flow
- Non–durable goods – used up immediately/short period of time – toilet paper, food, magazines
- Durable goods – used over a period of time – cars, computers, mobile phones, furniture
Affected by:
Income >> higher incomes create higher consumption (potential falling tax rates)
During periods of economic growth, unemployment is falling causing a scarcity in the no. workers, as
firms compete for the reduced no. of unemployed workers, increased salaries are offered as an
incentive
Interest Rates:
Higher interest rates: increase the cost of borrowing and people borrow less and spend less (fall in
consumption), make savings more attractive (savings replace consumption), increase monthly
repayments and people’s real incomes fall
Wealth >> if house prices rise people feel wealthier and consumption rises
Consumer Confidence/Changes in expectations >> if consumers feel positive about future economic
growth, they will spend more + brand loyalty – if negative consumers will be saving instead
Indebtedness >> if consumers have higher monthly mortgage repayments + other debts – they will
spend less due to reduced disposable income
Consumption increases when the value of stocks/shares goes up
INVESTMENT - I
- The demand of firms = firms investing in physical capital
- increase in capital stock, carried out by firms
- Replacement investment = when firms buy capital to maintain the same productive
capacity (replacement of old capital by new capital)
- Induced investment = when firms buy additional capital to increase output & productive
capacity
Affected by:
Interest Rates >> higher interest rates increase the cost of borrowing for firms, firms will be made to
save more of their profits, it will increase monthly outgoings and reduce
firms’ profits
Changes in NI >> higher NI will lead to higher consumption and firms will
invest to increase production
Technological changes >> to stay competitive firms have to acquire more
modern capital
Level of corporate indebtedness
Legal/institutional changes
, Expectations and business confidence
GOVERNMENT SPENDING – G
- The demand of the government
- Infrastructure / transport / communications – capital expenditure
- Current expenditure – wages/salaries of public sector workers
Affected by:
Changes in political priorities >> government may decide to increase/decrease its expenditures in
response (tends to increase spending during recession)
Changes in economic priorities >> deliberate efforts (demand-side policies) to influence/target AD >>
gov can use its spending to intentionally influence AD (part of fiscal policy)
Monetary policy – changes in interest rates and money supply
NET EXPORTS – (X – M)
- The demand of foreigners for export (X) – the demand for imports (M)
- EXPORTS = When a country sells domestically produced goods/services to foreigners. Results
in inflow of money into the country
- IMPORTS = When residents of a country buy goods/services from foreign producers. Results
in outflow of money
- if positive >> adds to AD, negative >> reduces AD
Affected by:
(exports) Incomes of trading partners
(imports) National income
Exchange rates (lower exchange rates make exports cheaper and more competitive)
Trade policies (free trade or protectionism)
Relative inflation levels/rates
← Changes in Aggregate Demand
Fiscal Policy:
= changes in taxes & gov spending
- Expansionary >> to increase AD in recession
o Increase in gov spending + reduction in taxes
o Leads to higher consumption & investment
- Contractionary >> to reduce AD
o Reduction in gov spending + increase in taxes
AD = (estimate of) total demand for goods/services in an economy at a given price level
1. CONSUMPTION
2. INVESTMENT
3. GOVERNMENT SPENDING
4. NET EXPORTS (X – M)
AD = C + I + G + (X – M) (= Real GDP)
- AD shows the inverse relationship between Average Price Level & Real
Output
- Real GDP/Output >> adjusted for inflation
CONSUMPTION – C
- The demand of consumers
- Total spending by consumers/households on DOMESTIC goods and services produced inside
the economy/circular income flow
- Non–durable goods – used up immediately/short period of time – toilet paper, food, magazines
- Durable goods – used over a period of time – cars, computers, mobile phones, furniture
Affected by:
Income >> higher incomes create higher consumption (potential falling tax rates)
During periods of economic growth, unemployment is falling causing a scarcity in the no. workers, as
firms compete for the reduced no. of unemployed workers, increased salaries are offered as an
incentive
Interest Rates:
Higher interest rates: increase the cost of borrowing and people borrow less and spend less (fall in
consumption), make savings more attractive (savings replace consumption), increase monthly
repayments and people’s real incomes fall
Wealth >> if house prices rise people feel wealthier and consumption rises
Consumer Confidence/Changes in expectations >> if consumers feel positive about future economic
growth, they will spend more + brand loyalty – if negative consumers will be saving instead
Indebtedness >> if consumers have higher monthly mortgage repayments + other debts – they will
spend less due to reduced disposable income
Consumption increases when the value of stocks/shares goes up
INVESTMENT - I
- The demand of firms = firms investing in physical capital
- increase in capital stock, carried out by firms
- Replacement investment = when firms buy capital to maintain the same productive
capacity (replacement of old capital by new capital)
- Induced investment = when firms buy additional capital to increase output & productive
capacity
Affected by:
Interest Rates >> higher interest rates increase the cost of borrowing for firms, firms will be made to
save more of their profits, it will increase monthly outgoings and reduce
firms’ profits
Changes in NI >> higher NI will lead to higher consumption and firms will
invest to increase production
Technological changes >> to stay competitive firms have to acquire more
modern capital
Level of corporate indebtedness
Legal/institutional changes
, Expectations and business confidence
GOVERNMENT SPENDING – G
- The demand of the government
- Infrastructure / transport / communications – capital expenditure
- Current expenditure – wages/salaries of public sector workers
Affected by:
Changes in political priorities >> government may decide to increase/decrease its expenditures in
response (tends to increase spending during recession)
Changes in economic priorities >> deliberate efforts (demand-side policies) to influence/target AD >>
gov can use its spending to intentionally influence AD (part of fiscal policy)
Monetary policy – changes in interest rates and money supply
NET EXPORTS – (X – M)
- The demand of foreigners for export (X) – the demand for imports (M)
- EXPORTS = When a country sells domestically produced goods/services to foreigners. Results
in inflow of money into the country
- IMPORTS = When residents of a country buy goods/services from foreign producers. Results
in outflow of money
- if positive >> adds to AD, negative >> reduces AD
Affected by:
(exports) Incomes of trading partners
(imports) National income
Exchange rates (lower exchange rates make exports cheaper and more competitive)
Trade policies (free trade or protectionism)
Relative inflation levels/rates
← Changes in Aggregate Demand
Fiscal Policy:
= changes in taxes & gov spending
- Expansionary >> to increase AD in recession
o Increase in gov spending + reduction in taxes
o Leads to higher consumption & investment
- Contractionary >> to reduce AD
o Reduction in gov spending + increase in taxes
