2.2 Aggregate Demand (Macro)

COMPONENTS OF AGGREGATE DEMAND

Consumer spending + Investment spending + Government spending + Export revenues minus Import payments

AD

Aggregate Demand

C+

Spending by households on goods and services

I+

Spending by firms on investment goods

G+

Government current and capital spending

(X-

Foreigners spending money in the domestic economy

M)

GROWING TRADE DEFICIT

All the economic benefits are being reinvested back into other countries and not their own (more imports then exports).

CONSUMPTION (C)

This is determined by the willingness and ability of UK households to buy goods & services. It is the largest component of UK aggregate demand (approximately 60%).

INVESTMENT SPENDING (I)

This is determined by the willingness and ability of firms to expand output. Makes up approximately 15% of AD. This is spending by UK private sector firms (including FDI – spending by foreign-owned businesses which operate in the UK economy) as well as government investment spending on capital goods

GROSS

 is the absolute most capacity spent

AGGREGATE DEMAND CURVE

Shows the relationship between the average price level and equilibrium national income.  As the price level rises the equilibrium level of national income falls.

AGGREGATE DEMAND CURVE SLOPING DOWNWARDS

Another reason for drawing a downward sloping AD are that, at higher average prices, an economy is less likely to export, more likely to import (decreasing the X component and increasing the M component of AD, and therefore decreasing AD overall) – the international competitiveness argument.

 A third reason why the AD curve slopes downwards is that, at higher average prices, the interest rate is likely to be higher, meaning that investment (a component of AD) is lower. Households and firms might also save more.