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Aggregate Demand
Defined:
Amounts of Real Output
Buyers Collectively Demand
At Each Possible Price Level
Aggregate Demand
AD
Y
5
AD
Reasons for downward slope of AD curve
Wealth effect
P Real income/wealth AD
Interest rete effect
P Interest rete AD
Foreign trade effect
P NX AD
AD
Other factors (factors other than Price
level) that influence Aggregate Demand
Level of income/ wealth
The rate of interest
Tax rate
Government policy
Economic conditions in other countries
Business confidence/ sentiments
Natural factors/ rainfall
AD
Other factors (factors other than Price
level) that influence Aggregate Demand
AD1
AD
AD2
Y
9
Components of Aggregate
Demand
Consumption Demand (Consumption of goods
and services by the private sector- C )
Investment Demand (Investment by the
private sector-I )
Government expenditure (C and I by
Government - G)
Net Exports ( C and I by external sector (X)
minus Imports (M)
Y = C+ I + G + X M
Actual GDP = Aggregate Demand
It is the aggregate spending by the private
sector, Govt. sector and net external sector on
consumption and investment goods and
Aggregate Demand is thus up made of
DISPOSABLE INCOME:
Divided into
Consumption
Savings
Components of consumption
Income
Wealth
Interest rate
Tax rates
Credit availability
Consumers expectations
Consumer Indebtedness
Income/wealth distribution
Fluctuations in Consumption
demand
Due to
C = a + bY
FIGURE - An Aggregate
Consumption Function
32
Determinants of Aggregate Investment
Expenditure
Interest rate more investments so long
as return from the investment exceeds
cost (interest rate)
Expected rate of profit (MEC)
Planned output net investment is
governed positively by the change in
expected output
Wage rate investment depends
positively on the wage rate (this factor is
relevant in the long run)
Tax laws
Availability of capital
Technology development
Business confidence/stock market
behaviour
Savings and Investment
linkage
Saving is consumption forgone - If savings
rise, consumption will fall.
Level of saving in the economy, like
consumption, depends basically on income.
Saving is inevitable for capital formation and
economic growth.
Saving itself has nothing to do with
economic growth unless properly mobilized
and effectively channelized and invested to
enhance capital stock to increase production
and wealth of the economy.
Savings form the backbone for investments
viz., higher savings lead to higher
investments and vice versa
Savings and Investment
linkage
We can speak of 4 sources of savings:
C + I + G + (X M) = C + S + T
Investment, Savings, and Foreign
Borrowing
Some simple manipulation produces the
following identity regarding the sources of
investment:
I = S + (T G) + (M X),
Where,
government consumption
government investment
transfer payments
Government consumption: Government
purchases of goods and services for current
use
It includes Govt. spending on purchase of goods and
services-stationary, medicines, uniforms for Govt.
hospitals, payment for services provided by Govt.
servants like police, defense, other Govt.
ministries, and so on
Government investment: Government
purchases of goods and services intended to
create future benefits
Eg: Infrastructure investment, setting up public
sector enterprises, research spending and so on
Transfer payments: Government
expenditures that just represent transfers of
money.
They are just transferred from one section of the
society (tax payers) to another section(who
need it) without adding to production. (and
4. Net Exports (X - M)
Net Exports Is a component of the total
expenditure (Aggregate Demand)
Is the value of a country's total exports
minus the value of its total imports.
It is used to calculate a country's aggregate
expenditures, or GDP, in an open economy.
It is the amount by which foreign spending
on a home country's goods and services (our
exports) exceeds the home country's
spending on foreign goods and services (our
imports).
For example, if foreigners buy $200 billion worth of U.S.
exports and Americans buy $150 billion worth of
foreign imports in a given year, net exports would be
positive $50 billion.
It represents the net foreign demand for
domestic goods and services and an
increase in this will lead to an increase
AD and vice versa.