aggregate demand

Aggregate demand

Total demand of all goods and services within a country in a given period of time

Components of AD

1. Consumption

2. Investment

3. Government spending

4. Exports - Imports

Formula of AD

C + I + G + (X-M)

Consumption

Spending on consumer goods and services over a period of time

Factors affecting consumption

1. Wealth

2. Inflation

3. Interest rates

4. Availability of credit

5. Expectations

6. Composition of households

7. Changes to tax rates

Income

Money received as payment from work

Savings

What is not spent out of income, usually in a bank account

Marginal propensity to consume

Proportion of a change in income that is spent instead of saved

MPC =

Change in consumption ÷ Change in income

Average propensity to consume

Proportion of total income an individual or a nation spends on consumption

APC=

Consumption ÷ Income

Wealth effect

As the value of assets like homes and stocks increases, people feel wealthier and spend more, which stimulates economic growth and vice versa

What is wealth made up of

1. Physical wealth (houses, cars)

2. Monetary wealth (cash, stocks

2 ways inflation affects consumption

1. If households expect inflation in the future they will push consumption forward

2. Inflation erodes the real value of money so consumption will decrease and people will save more

Composition of households

The number, gender, age, and relationships of people living in a household:

• Young people spend more than middle aged people

• Old people will run down their savings and consume more

Interest rates

The cost of borrowing money or the reward for saving it, expressed as a percentage of the principal amount

Investment

Spending on capital goods, physical assets that produce goods and services

Gross investment

Total capital spending before depreciation

Net investment

Gross investment - Capital depreciation

Significance of investment

1. Injection of demand for capital goods industries

2. Investment can lift productivity/incomes

3. Economies of scale and better competitiveness

4. Investment helps to sustain export let growth

Accelerator effect

• Changes in investment spending by firms are directly proportional to the rate of change in national income or GDP

• A small increase in consumer demand can lead to a proportionally larger increase in investment in capital goods, like machinery or factories, as firms rush to meet anticipated future demand.

Government spending

Expenditure by a government on education, health care, defence and other public services

Exports

Goods sold from one country to another, they are an injection into the circular flow of income

Imports

Goods a country purchases from another country, a leakage from the circular flow of income

Trade surplus

Exports are larger than imports, AD will rise

Trade deficit

Exports are less than imports, AD will fall

Net trade balance/Net exports

Exports - Imports