Aggregate demand
Aggregate demand is the total demand for goods and services produced in an economy at a given price level and time period. This expenditure comes from households, government, firms and foreigners. It’s made up of C+I+G+(X-M), which is Consumption + Investment + Government spending + net exports (which is Exports – Imports.)
If country has a trade surplus, which means exports are more than imports, but if we ad to it C + I + G that will increase aggregate demand. If the country has trade deficit, this means aggregate demand would be lower than domestic demand.
Consumer expenditure
Range of influences, how much households spend? They include:
-Real disposable income. For example richer, spend more than poor. They have more money to spend. The income which is spent is called Average propensity to consume (APC) may fall as disposable income rises. For example an office worker which is earning 10000$ a week will spend more than teacher earning 1000$ per week. An office worker can spend 7500$ per week, while the teacher will spend 900$. In this case the teaches has higher APC- 0,90 (900$/1000$) than and office worker who has an APS of 0.75 (7500$/10000$)
-Consumer confidence and expectations: It’s when consumers feel optimistic about the future. Because of their over confidence they spend more.
Saving
Influences on saving include:
- Real disposable income
- The rate of interest
- Confidence and expectations
- Saving schemes
- Range of financial institutions
- Government policies
- The age structure of the population
Investment
Influences on investment include:
- Change in real disposable income
- Expectations
- Capacity utilization
- Current profit levels
- Corporation tax
- The rate of interest
- Advances in technology
- Price of capital equipment
Government Spending
Government spending decisions are influenced by a number of factors. These include:
- The government view on the extent of market failure and it’s ability to correct it.
- The level of economic activity in the economy can influence government spending.
- A desire to please the electorate
- War, terrorist attacks and rising crime, or their threat, can also boost government spending.
Net exports
The influences on export revenue and import expenditure are:
- Real disposable income abroad
- Real disposable income at home
- The domestic price level
- The exchange rate
- Government restrictions on free trade
aggregate demand curve
An increase in aggregate demand
Downward sloping AD curve
Three effects which explain downward slope in AD:
The wealth effect: Relates to a change in households and firms real wealth. Fall in the price level increases the amount of goods and services, that wealth kept in the form of money in bank accounts and other financial assets, can buy. Therefore rise in the price levels causes aggregate demand to contract.
The rate of interest effect: Rise in the price level means that some people will sell assets to obtain more money to pay greater prices. A high interest rate may reduce consumption and investment. A fall in the price level will reduce the interest rate and cause an extension in AD, because of the higher consumption and investment.
The international trade effect: Rise in the price level, but exchange rates and foreign prices had no change will make country’s products less internationally competitive. Households and firms will buy more from foreign producers and less from domestic producers. And net exports would fall causing AD to contract. So Ad curve slopes down from left to right, since the rise in price level will cause a decrease in monetary wealth and an increase in interest rate and country’s international competitiveness will be reduced.
Aggregate supply
Aggregate supply is the total output of goods and services that producers in an economy are willing to supply at different price levels in a given time period.
Any increase in output can be achieved by employing more efficient workers and new machinery’s. But as the resources become more scarcer, producers have to employ less efficient workers and new machinery’s. At full capacity it’s not possible to produce any more, even if the price level is really high.
A change in AS means total output that produces are willing to so supply at a given price changes. A decrease in AS is represented by a shift to left, Increase in AS is represented by shift to right. The main change in AS are because of the changes in cost of production. If cost of production falls, AS will shift to right, causing an economics growth. Rise in the cost of productions will shift AS to left.
Macro economic Equilibrium
Occurs when Aggregate demand and Aggregate supply are equal. When Aggregate demand and Aggregate supply are equal, there’s no reason for the economy’s output to change. Total output and price level will be stable.
If Aggregate demand would be higher than aggregate supply, it would cause shortage of goods and services. Firms will extend their output to increase the total capacity.
If the Aggregate supply exceeds aggregate demand, the economy would move back to equilibrium. This time unsold goods and services would contract aggregate supply.
Anything that causes aggregate demand or aggregate supply to change will move the economy to new macroeconomic position.
Output gap
Output gap exists when economy is not producing at full capacity. Negative output gap occurs when economies actual output is less than it’s potential output. But opposite if this process causes positive output gap.
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