Aggregate demand

Aggregate demand is the value of all goods and services demanded in the economy, within a particular time period, usually a year.

AD curve shows the %%real national output purchased%% at each price level.

Inverse relationship between general price level and the real GDP (components of the AD curve.)

  • WEALTH EFFECT Pigou- fall in the general price level, affects purchasing power of the individuals, which results in a greater consumption.
  • INTEREST RATES EFFECT Keynes’s - fall in the general price level caused also interest rates to fall, that increase the disposible income and there is an incentive for consumers to borrow money, therefore increase their consumption and investments (higher aggregate demand in the economy)
  • EXCHANGE RATE EFFECT Mundell Fleming’s- fall in the general price level caused increase demand for the net exports, because it is more affordable for foregin buyers to purchase some products(domestic products are cheaper) from the country that have cheaper currency. That decrease the demand for net imports.

Aggregate demand = C + I + G + (X − M)

Consumption - is the total spendings on goods and services within an economy per particular time period

Investments - total expenditure of all firms in order to increase their capacity and production capacity.

Goverment spendings - is the @@total expenditure@@ on goods and services on the public sector.

Net exports - measures the difference value between net exports and net imports of the country.

Determinants of AD components: cause the curve to shift

  1. Consumption
       * consumer confidence - the more consumers are confident about an economy, the greater their level of consumption
       * wealth (total market value of all physical assets owned) - wealthier housholds are more likely to consume more
       * interest rates(costs of borrowing money) -increase of interest rates will cause reduced level of consumption, because it will be less affordable for consumers to borrow money to finance their expenditure.
       * income taxes(disposibal income) - higher income taxes therefore the level of disposibal income fall that results in reduced consumption
       * level of household indebtedness - the value of household debts that needs to be repaid with interest. Short-run shift of AD rightward that might result in a later leftward shift as debt is repaid
       * expectation of the future price level - when consumers expect an increase of general price level due to inflation, they decided to spend money now. If they expected deflation they decided to save some money and spend less in the future due to lower prices.
  2. Investments
       * interest rates - higher interest rates make less affordable for firms to borrow money, so they are less likely to invest. Higher interest rates reduce the investment expenditure therefore shifting the AD curve to the left.
       * business confidence - high business confidence is when the economy is growing and there is an increase of national income and employment. Firms are more likely to invest and spend money.
       * technology - technology progress boost the investment expenditure.
       * business tax - higher business taxes reduce the amount of money for investments. eg. ^^Estonia and The Bahamas have zero rate of corporation tax^^.
       * level of corporate indebtedness - more debts the business have therefore the less money are avaliable for investment expenditure. Indebtedness tends to increase during time of rising interest rates.
  3. Government spending
       * political priorities - Depending on priority of general election they can spend more on public sector like education and healthcare or increase their expenditure on social welfare during high unemployment.
       * economi priorities- goverment intervention and government spendings are crucial to support the economy that will boost the level of aggregate demand. e.g tax increases
  4. Net exports
       * income of trading partners - when a particular country, which is a trading country for example for Poland, have an economic downturn. That leads to fewer exports and fall in AD. As incomes have risen in the emerging markets, a greater demand for the exports of the developed markets has resulted in a shift of AD.
       * exchange rate - price of the currency determine the relative prices of goods and services traded. Import make the leftward shift of the AD curve.
       * trade policies - some countries can implement trade barriers that will be a restrictions for imported good from another countries, It can be in the form of impose tax known as tariffs like cło, imposed restrictions on volume of goods.