14 Aggregate Demand

What is aggregate demand

• macro AD curve has a measure of APL of all goods and services

• shows relationship between APL and real output

Components of AD

• consumption

  • Total spending by consumers of domestic goods and services

• investment

  • Carried out by firms

• government spending

  • depends on policies and objectives

• Net exports (X - M)

  • can be + or -

Two types of investment

• replacement investment: firms spend on capital to maintain productivity of existing capital

• Induced investment: firms spend to increase output due to higher demand

What causes change in consumption

1. Change in income tax

   • if income tax increase, C falls

2. Change in interest rate

   • if interest rate increases, less borrowing, C decreases

     • saving increases

   • decrease in interest, C goes up

3. Change in wealth (wealth made up of assets people own) (other flashcard)

4. change in consumer confidence

   • optimistic about future - spend more now

   • higher confidence , increase c

   • if consumers expect inflation, increase in C now

5. level of household indebtness

   • if easy to borrow, spending increase

   • if IR increases, more to pay back, less to spend

factors changing wealth

1. change in house prices: when house prices increase, consumers feel more wealthy, enough to increase C

2. Change in value/stock shares: Value increases, people feel wealthier or sell shares

What casues change in investments

1. change in interest rate

   • If interest rate increases, less investment

   • If interest rate decreases, more investment

2. change in business taxes

   • If G increases tax on profits, reduce post tax profits, less money, less AD

   • G manipulation of corporate taxes, fiscal

3. technological change

   • firms need to invest to stay up to date, AD increase

4. change in business confidence

   • if confident about future, invest to increase potential output and productivity

5. level of coorporate indebtness

   • if easy, borrow more

   • if IR increases, more debt, less money

Change in net export

1. Changes in level of export

   • if foreign income increases, then C on imports increases

     • exports of other country grows as foreign economy grows

   • If country’s exchange rate stronger, makes country’s exports more expensive to foreigners

     • exports fall

2. Change in level of imports

   • As NI increases, so do imports