Aggregate demand 2.2.1

What is aggregate demand?

Total planned real expenditure in a countries goods and services produced within an economy in each time period

What are the components of aggregate demand?

• Household spending on goods and services- C

• Gross fixed capital investment spending and the value of the change in stocks- I

• Government spending on public services- G

• Exports of goods and services- X

• (minus) Imports of goods and services- M

What is the formula for Aggregate Demand?

AD = C + I + G + (X-M)

In the formula for AD what does C + I + G represent?

domestic demand

In the formula for AD what does (X-M) represent?

net exports (trade balance)

What are the three reasons why the AD curve slopes downwards?

• Real income effect

• Balance of trade effect

• Interest rate effect

What is meant by the real income effect?

As the price level falls, the real value of income rises, and consumers can buy more of what they want or need- this is known as the real money balance effect

What is meant by the balance of trade effect?

A fall in the relative price level of country x could make foreign produced goods and services more expensive, causing a rise in exports and a fall in imports.

What is meant by the interest rate effect?

If price inflation is low and this might lead to a reduction in interest rates if the central bank has a given inflation target. Lower interest rates means there is less incentive to save and a fall in interest rates may cause the exchange rate to depreciate and improve exports.

What are causes of shifts in the AD curve?

• Changes in real income and employment

• Changes in government spending, taxation and borrowing

• Changes in monetary policy interest rates and the supply of credit

• Changes in the external value of a country’s exchange rate

• Changes in the rate if economic growth of trading partner nations

• Fluctuations in consumer and business confidence

What is business confidence?

Describes the forward-looking expectations of firms