3.2.1 aggregate demand

aggregate demand

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

value of AD

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

if AD increases

economic growth has occurred, vice versa

economic growth

increase in national output as measured by real gDP

consumption

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

investment

the total spending on capital goods by firms

government spending

the total spending by the government in the economy

(public sector salaries, payments for the provision of merit/public goods - does not include transfer payments)

net exports

the difference between the revenue gained from selling g/s abroad and the expenditure on g/s from abroad

➜ (revenue gained from exports - expenditures on imports)

a 1% increase in consumption/govt. spending...

will have a much larger impact on economic growth than a 1% increase in net exports

aggregate demand curve

downward sloping

➜ shows the relationship between the average price level and the total output in an economy

with lower average price levels...

there is greater aggregate demand

change in APL in an economy

➜ movement along the AD curve

increase in the average price level...

contraction of rGDP

change in non-price determinants of AD

entire AD curve shifts

components of aggregate demand

consumption

investment

government spending

net exports

factors of CONSUMPTION

- consumer confidence

- interest rates

- wealth

- income taxes

- level of household indebtedness

- expectations of future price level

consumer confidence ➜ strong economy

- stronger economy = higher consumer confidence

➜ consumers feel secure in their jobs and are receiving regular salary payments

➜ consumption increases, saving decreases

consumer confidence ➜ recessionary economy

- weakening/recessionary economy = confidence falls

➜ consumers feel less secure in their jobs

➜ consumption decreases, saving increases

interest rates increase

- change in base interest rates will change level of consumer spending and savings

- if interest rates increase = greater incentive to save

➜ more saving = less consumption

➜ higher loan repayments = less consumption

wealth

- consumer wealth increases = consumption increases

- rising property/share prices give consumers confidence to borrow more

➜ more borrowing = more consumption

income taxes

- disposable income is the money that households have left from their salary/wages after they have paid taxes and received any transfer payments/benefits

➜ if taxes increase, disposable income decreases, consumption decreases

level of household indebtedness

- debt is usually repaid with monthly payments

- higher level of debt = higher monthly repayment

➜ less money available for new consumption

expectations of future price level

if consumers believe prices will rise in the future, they are incentivised to consume now, vice versa

factors that influence INVESTMENT

- changes to interest rates

- business confidence

- technology

- business taxes

- level of corporate indebtedness

interest rates

- most investment by firms is financed through business loans

- decreasing interest rates encourage investment

➜ inverse relationship between investment and interest rates

business confidence

- firms choose to invest if they feel confident that they will make a good return on their investment

- the longer a period of economic growth, the higher business confidence will be

➜ if growth slows, future expectations of profits will decrease and investment decisions become harder

technology

when a firm identifies new technology which will reduce costs and raise output, they are incentivised to invest

business taxes

- when govt. raise business taxes, it reduces the profits of firms

➜ less profits = less money available for investment

level of corporate indebtedness

- corporate debt usually repaid in monthly repayments

- higher level of debt = higher monthly repayment

➜ less money available for new investment

factors that influence GOVERNMENT SPENDING

- political priorities

- economic priorities

political priorities

- governing parties have different political priorities which influence spending

- some parties believe the state should provide more g/s and spending increases

- other parties believe the role of govt. should be smaller and spending decreases

economic priorities

- fiscal policy is set once a year and announced during the year

- expenditure is directly related to the government's objectives and policy aims

➜ e.g. a policy aimed at upgrading a country's rail network requires increased expenditure

factors that influence NET EXPORTS

- income of trading partners

- exchange rates

- trade policies

income of trading partners

- when the household income of trading partners increases, foreigners purchase more products ➜ exports increase

- when income of trading partners decreases ➜ exports decrease

exchange rates (imports)

- when domestic currency appreciates, consumers' money goes further abroad ➜ imports increase

- when domestic currency depreciates, consumers' money goes less far abroad

➜ imports decrease

exchange rates (exports)

- when domestic currency appreciates exports are more expensive for foreigners ➜ exports decrease

- when domestic currency depreciates, exports are less expensive for foreigners ➜ exports increase

trade policies

- if protectionism increases, there is decreased demand for imports as they are more expensive

- if protectionism decreases there is increased demand for imports as they are less expensive ➜ exports usually increase due to free trade