Macroeconomics/Aggregate Demand

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If you are familiar with some basic microeconomics, particularly the demand and supply curves, this section shouldn't be too demanding. Aggregate Demand or Aggregate Expenditure (abbreviated to AD and AE respectively) is essentially the demand curve for goods and services for a whole economy. There are determinable parts, known as components of aggregate demand, which the next few pages will explain in more detail.

Components of Aggregate Demand[edit | edit source]

The formula for finding AD is as follows:

AD = C + I + G + X - M

Consumption (C)[edit | edit source]

This is the expenditure by consumer on goods and services, including both durable and non-durable goods but not including saving. While values vary widely between economies, 'C' usually accounts for 40-60% of GDP. Because of this, high or low consumer confidence, and consequently high or low consumer spending can change the course in an economy.

Investment (I)[edit | edit source]

Strictly known as Gross Domestic Fixed Capital Formation, this is the money spent by firms (not the government or consumers) on capital investment i.e. new machinery and factories. There is some argument as to whether human capital (training) should be included. Investment also includes stocks and goods and services not yet completed; for example, car firms will likely have many machines part-built or stored at any one time. Since they cannot be included in consumption since they have not been purchased, stores must be included in I.

Investment makes up approximately 10% of GDP in most economies, and governments are often keen to increase this value, as investment helps to increase the possible output of economy (strictly LRAS or the PPF).

Government Spending (G)[edit | edit source]

Strictly known as General Government Final Consumption, it is the expenditure by the government, not including transfer payments (e.g. social security, welfare benefits since they are simply moving money around the economy). Governments usually spend on public and merit goods. These are microeconomic terms - a public good is one that is provided to everybody and cannot be exclusive by its nature (think street lighting), whilst a merit good is one that is under-supplied and under-demanded as consumers do not appreciate all the benefits, because some of those benefits do not directly apply to the buyer (think environmentally friendly vehicles).

Changes in government spending as a method of controlling the economy is known as fiscal policy - more of that later on.

Exports and Imports (X-M)[edit | edit source]

Exports are a positive figure on Aggregate Demand as overseas customers purchase goods and services produced here. Imports, on the other hand, are not produced here, though they are consumed here. Think of imports as money leaving the economy.

Aggregate Demand Curve[edit | edit source]


Shifting the AD Curve[edit | edit source]

Shifting of the AD curve occurs when there is any change in any of the four components of Total Expenditure, i.e., C, I, G or (X-M). If there is an increase in Total Expenditure then the Aggregate Demand Curve shifts rightwards. Again, when there is a decline in total expenditure, the aggregate demand curve shifts leftwards.

more diagrams!