Aggregate Demand

AD is the Total Demand for goods and services produced within the economy over a period of time. AD is the sum of planned expenditure for goods and services.

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:


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

 

Shifts in the Aggregate Demand curve

ad

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 I

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

i) Government pursues expansionary fiscal policy
ii) Governments invests in infrastructure

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

Essays and Revision Notes on Economic Growth