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Aggregate Demand
• The sum of all expenditure in the economy
over a period of time
• Macro concept – WHOLE economy
• Formula:
AD = C+I+G+(X-M)
– C= Consumption Spending
– I = Investment Spending
– G = Government Spending
– (X-M) = difference between spending on
imports and receipts from exports (Balance
of Payments)
2.0%
AD
Y2 Y1
U = 5%
Real National Income
U = 7%
2.0%
AD2
AD
Y1 Y2
U = 5% U = 2%
Real National Income
Consumption Expenditure
• Exogenous factors affecting consumption:
– Tax rates
– Incomes – short term and expected income over
lifetime
– Wage increases
– Credit
– Interest rates
– Wealth
• Property
• Shares
• Savings
• Bonds
Investment Expenditure
• Spending on:
– Machinery
– Equipment
– Buildings
– Infrastructure
• Influenced by:
– Expected rates of return
– Interest rates
– Expectations of future sales
– Expectations of future inflation rates
Government Spending
• Defence
• Health
• Social Welfare
• Education
• Foreign Aid
• Regions
• Industry
• Law and Order
Key Variables
Macroeconomic Policy
Fiscal Policy
Monetary Policy
Aggregate Supply
Inflation AS Between Y1 and Yf,
The
This
Yf shape in of
shape
Anrepresents
output
increases the
level AS
‘Full
of
capacity Y1
are
curve
wouldissuggest
Employment
possible important
but thein –
theOutput’
nearer
reflects
determining
the
at economy
economy
this point agets
is the to Yf,
working
Keynesian
the morefull
outcome
economy
below problems
in the view
iscapacity
workingare to
experienced
economy
full
andcapacity with
there wouldand be
of the
acquiring
cannot
widespread
AS curve.
resources
produce
to
any
Economy starts to overheat boost production
more.
unemployment.
(production bottlenecks)
especially labour skills
shortages.
Y1 Yf
Real National Income
Aggregate Supply
Inflation
AS1 AS2
Increases in
capacity can
occur as a result
of a shift in AS
(akin to a shift
outwards of the
Production
Possibility
Frontier) (PPF)
Aggregate Supply
Inflation SRAS assumes
Short run
costs suchsupply
aggregate as
overall assumes
(SRAS) wage
firms only able to
rate remain
increase output at
SRAS 1 fixed, changes
higher costs (e.g.
in such costs
overtime
cause a shift in
payments)
the SRAS
thereby curve
pushing
SRAS (exogenous
up price level
shocks – input
costs)
SRAS 2
Aggregate Supply
Inflation LRAS This is because they
Classical
believe that in the
economists
long run, there will be
assume
no the long
unemployment of
resources because
run aggregate
markets will clear,
supply curve
thus whatever the
(LRAS) is vertical
rate of inflation, firms
will supply the
(perfectly
maximum capacity of
inelastic).
the economy.
Aggregate Supply
Inflation AS
For our analysis,
we will assume
the AS curve
looks like this!
2.0%
AD 1
AD
2.0%
AD1
AD
Yf
Y1 Y2 Y3 Real National Income
Sustained Growth
Inflation AS AS1
Sustained
growth (not to
be confused with
sustainable
economic
growth) occurs
when AS and AD
rise at similar
rates – national
income can rise
without effects
on inflation
2.0%
AD2
AD
Y1 Y2 Real National Income