2.2.1 - characteristics of aggregate demand

define aggregate demand

total demand for all goods/services in an economy at any given average price level

how is aggregate demand calculated

using the expenditure approach:

Consumption + Investment + Government spending + (eXports - iMports)

AD and economic growth

if ad increases, economic growth has occured

and vice versa

define consumption

the total spending on goods + services by consumers (households) in an economy

define investment

the total spending on capital goods by firms

define government spending

the total spending by the government in the economy

what does gov spending include and not include

INCLUDES:

• public sector salaries

• payments for provisions of merit and public goods

DOESN’T INCLUDE:

• transfer payments

transfer payments = a payment by the gov for which no goods/services are received (eg benefits)

define net exports

the difference between the revenue gained from selling goods/services abroad, and the expenditure on goods/services from abroad

who does exporting and importing

all three economic agents: individuals, firms, gov

how much does each component contribute to AD

C - 60%

I - 14%

G - 25%

(X-M) - 1%

so a 1% increase in C or G would have a greater impact on economic growth than the same increase on X-M, for example

how is AD shown

with an AD curve:

y axis = average price level

x axis = total output (real GDP)

3 reasons why the graph is downwards sloping

the interest rate effect

the wealth effect

the exchange rate effect

the interest rate effect

higher average price (AP) levels = higher interest rates

higher interest rates = less spending, more saving

less spending, more saving = lower AD

and vice versa

the wealth effect

higher AP = lower purchasing power for households = lower AD

and vice versa

the exchange rate effect

lower AP = lower interest rates = lower exchange rate

low exchange rate = economy’s goods/services are attractive abroad = more exports = more GDP (output)

and vice versa

what causes a movement ALONG the ad curve

a change in the AP of an economy

(movements called contractions + expansions)

what causes a SHIFT of the ad curve

a change in any of the determinants of aggreagate demand (C+G+I+(X-M))

increase in any of them = shift outwards (and vice versa)