Aggregate Demand

Aggregate Demand (AD) is the total demand for goods and services produced within the economy over a period of time.

Aggregate Demand (AD) is composed of various components

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

C = Consumer expenditure on goods and services.
I = Gross Capital Investment – i.e. investment spending on capital goods e.g. factories and machines
G = Government Spending e.g. spending on NHS, education. Note transfer payments in the form of pensions and unemployment benefits are not included because they are not related to output produced.
X = Exports of goods and Services. Goods leave the country but money from abroad flows into the economy, therefore this is an increase in AD (an injection in to the circular flow)
M = Imports of goods and Services, although goods enter the country money is leaving the economy to go to other countries, therefore AD falls

AD slopes downwards because:

At a lower price level people are able to consume more goods and services, because there Real income is higher
At a lower price level interest rates usually fall causing increased AD
At a lower price level, exports are relatively more competitive than imports.

Graph to show Increase in AD

An increase in AD (shift to the right of the curve) could be caused by a variety of factors

1. Increased Consumption:

i) An increase in consumers wealth (higher house prices or value of shares)
ii) Lower Interest Rate which make borrowing cheaper therefore people spend more on credit cards. Also mortgage payments are cheaper which gives people more disposable income.
iii) Higher wages
iv) Lower Taxes
v) Increased consumer confidence about the future

Consumer Expenditure accounts for about 66% of AD and therefore is a very important component of AD

2. Increased Investment

i) Lower interest rates, this makes borrowing for investment cheaper.
ii) Increased confidence in the economic outlook
iii) Improved technology
iv) Increased economic growth, to meet increased demand firms need to increase capacity

3. Increased G

4. Increased X

i) UK more competitive, for example an increase in labour productivity would make the UK more competitive
ii) Increased growth in other countries, therefore they will have higher demand
iii) Lower value of Sterling, this makes exports cheaper

5. Decreased M

i) UK more competitive, this makes goods from other countries appear less competitive.
ii) Lower value of Sterling, this makes imports more expensive
iii) Lower GDP, therefore consumers will have less money to spend.

A graph showing components of AD as a %

In the above charts, I left out 2 minor factors NPISH and change in inventories to make it simpler.

TABLE 3 - UK GDP
COMPONENTS OF DEMAND - £bn, 2006 prices
	Final consumption expenditure				Change in inventories
	Final consumption expenditure
	HH	NPISH1	Government	GFCF2		Exports3	Imports3	Real GDP4
	ABJR	HAYO	NMRY	NPQT	CAFU	IKBK	IKBL	ABMI
2007	890.9	36.6	310.6	253.6	7.8	417.5	467.6	1449.9
2008	878.0	35.8	315.6	241.4	1.7	422.9	462.0	1433.9
2009	847.0	34.5	315.4	209.1	-12.5	382.9	405.5	1371.2
2010	857.4	34.9	320.1	215.6	4.9	411.1	440.4	1399.9
2011	850.6	34.1	320.3	213.0	5.6	430.0	445.7	1409.0

AD slopes downwards because:

At a lower price level people are able to consume more goods and services, because there Real income is higher
At a lower price level interest rates usually fall causing increased spending.

Notes

1 Non-profit institutions serving households.
2 Gross fixed capital formation. - Investment
3 Goods and services.
4 GDP at constant (2006) market prices

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