Components of Aggregate Demand
The components of aggregate demand are the total spending on goods and services within an economy. They include consumption by households, investment by businesses, government spending, and net exports (exports minus imports). These components are used to measure and analyze the overall demand for goods and services in an economy.
7 Key excerpts on "Components of Aggregate Demand"
eBook - ePub- W. Charles Sawyer, Richard L. Sprinkle(Authors)
- 2020(Publication Date)
- Routledge(Publisher)
...In Chapter 13, we described this approach and indicated that there are four different sectors of an open economy that buy real goods and services. The first component is public consumption, C, or consumer spending on goods and services. The second spending component is business investment and public spending on new housing, I. The third component is spending by national, state, and local governments on goods and services, G, not including any government spending for transfer payments. Finally, there are two familiar foreign sector components, exports, X, and imports, M, of goods and services. Exports form an addition to total spending by adding foreign demand to domestic demand. Imports are subtracted from total spending, as they represent domestic spending on foreign goods and services. A country’s aggregate demand is composed of consumption, investment, government spending, exports, and imports. If or when any of these Components of Aggregate Demand change, the entire aggregate demand curve shifts in one direction or another. A number of factors influence each of the Components of Aggregate Demand. For most countries, the largest component of aggregate demand is consumption spending, C. 5 Public consumption can change for a number of reasons that are not related to the price level. First, consumption is sensitive to changes in consumer wealth. Earlier in this chapter the discussion of wealth and consumption focused on how changes in the price level affected wealth. However, consumer wealth can change for reasons unrelated to the price level. As the level of consumer wealth increases or decreases, the level of consumption moves in the same direction. As consumption spending increases or decreases, the aggregate demand curve would shift to the right or left, respectively. Second, consumer expectations about the future course of economic events can change current consumption and change the aggregate demand curve...
eBook - ePubEconomic Principles and Problems
A Pluralist Introduction
- Geoffrey Schneider(Author)
- 2021(Publication Date)
- Routledge(Publisher)
...The economy always ends up at the equilibrium price level and real GDP where AD = AS. Next, we turn to more details regarding the aggregate demand and aggregate supply curves. Aggregate demand (AD) is the total quantity of output (of goods and services) demanded by all sectors in the economy at various price levels. Aggregate demand is made up of five components: consumption (C), investment (I), government spending (G), exports (X), and imports (IM). A D = C + I + G + X − I M. Consumption refers to consumer purchases of goods and services. Investment refers to businesses’ purchases of investment goods and services, such as machinery, equipment, and construction services that expand the physical size of businesses’ operations. Government spending includes all government purchases of goods and services, such as the services of soldiers and teachers, the construction of roads, and so on. Exports refers to foreign purchases of domestically produced goods and services, such as U.S. exports to Europe. Imports refers to domestic purchases of foreign-produced goods and services, such as U.S. imports from Europe. Note that imports are subtracted from aggregate demand because increased spending on imports means that less money is spent in the domestic economy. Slope of aggregate demand. The aggregate demand curve slopes downward because of three effects: The real balance effect: Higher prices mean less real wealth for consumers, causing consumers to spend less. Similarly, lower prices increase consumers’ purchasing power, leading to increases in consumer spending. The real interest rate effect: Higher prices cause real interest rates to rise because firms and individuals need to borrow more money to pay for more expensive goods. This results in decreases in spending on goods purchased with borrowed funds, including consumers’ purchases of houses and cars and businesses’ purchases of investment goods. The foreign trade effect: Higher prices on U.S. goods and services makes U.S...
eBook - ePubFoundations of Macroeconomics
Its Theory and Policy
- Frederick S. Brooman(Author)
- 2017(Publication Date)
- Routledge(Publisher)
...However, National Expenditure cannot be used in place of aggregate demand, since they are quite distinct concepts and are equal only when the economy is in equilibrium. The total of National Expenditure is necessarily identical with National Product, because nothing can be sold without being bought; such an identity can therefore tell us nothing about the conditions of equilibrium. But the total of aggregate demand need not be equal to National Product, just as demand need not equal supply in the market for a single commodity; there is no reason why buyers should always wish to buy exactly the quantity that sellers wish to sell, and indeed the two sides of the market will find that their respective intentions are mutually compatible only when equilibrium exists. For the equilibrium of the whole economy, then, aggregate demand is the significant magnitude, not National Expenditure. Nevertheless, this does not mean that the attention given to National Expenditure in the previous chapter was wasted. When aggregate demand is submitted to more precise definition, it must fall into the same mold as the details of total “Expenditure on National Product” or Na-tional Expenditure were found to do. Just as it was necessary to eliminate expenditures on intermediate products and to count only purchases of final goods and services, so also in the case of demand double counting must be eliminated by including only “final” demands in the total. The demand for fixed capital formation can be taken as gross or net, according to whether it is made to include or exclude depreciation, just as actual expenditure may be gross or net. The classification of demand into categories – consumers’ demand, government demand for goods and services, and so on – follows logically exactly the same pattern as that adopted for expenditure. If statistics of demand were available, they could be tabulated in a form precisely similar to that of Table 2.2 (p...
eBook - ePubContemporary Economics
An Applications Approach
- Robert Carbaugh(Author)
- 2016(Publication Date)
- Routledge(Publisher)
...An economy is in equilibrium when aggregate demand equals aggregate supply. The aggregate demand curve shows the total amount of real output that buyers will purchase at alternative price levels during a given year. Movements along an aggregate demand curve are caused by changes in the price level of the economy. Shifts in the aggregate demand curve are caused by changes in non-price factors that affect household consumption expenditures, business investment, government expenditures, and net exports of goods and services. According to the multiplier effect, a change in any one of the Components of Aggregate Demand (consumption, investment, government spending, or net exports) will have a magnified impact on national output and income. The size of the multiplier depends on the spending and saving habits of consumers and businesses. The aggregate supply curve shows the relationship between the level of prices and amount of real output that will be produced by the economy in a given year. The aggregate supply curve is horizontal when the economy is in deep recession or depression, upward-sloping when the economy approaches full employment, and vertical when the economy achieves full employment. Changes in factors such as resource prices, resource availability, and the level of technology will cause the aggregate supply curve to shift. The model of aggregate demand and aggregate supply can be applied to the problems of recession and inflation. According to this model, decreases in aggregate demand or aggregate supply can push the economy into recession; inflation may be the result of increases in aggregate demand or decreases in aggregate supply...
eBook - ePubMacroeconomic Theory: A Short Course
A Short Course
- Thomas R. Michl(Author)
- 2015(Publication Date)
- Routledge(Publisher)
...He proposed that investment depends at least partly upon the mood of business managers and entrepreneurs, which he called their animal spirits. To a large extent, this perspective resists the kind of formal, mathematical modelling that we rely upon in this book. The best way to bring this perspective back into these models is to recognize that the investment function may be subject to considerable instability due to changes in the animal spirits of investors. 3.3 Aggregate demand Aggregate demand is the sum of consumption, investment, and government spending. In general, the aggregate demand function is written Z = Z(Y) = C(Y) + I(Y, i) + G, where Z represents aggregate demand. Since both consumption and investment are direct functions of the level of income, we expect aggregate demand to be directly related to income. As a first approximation, we are assuming that investment is constant. The linear form of the aggregate demand equation is derived by substituting the linear consumption equation and the constant level of investment into this equation. It is written, (3.4) Z = [ c 0 − c 1 T + I ¯ + G ] + c 1 Y Notice that the aggregate demand function is presented above in intercept-slope form. The slope of the aggregate demand function is the marginal propensity to consume. This makes good sense, because consumption spending is the only kind of spending that responds to changes in the level of income under the assumption that the marginal propensity to invest is zero. 3.4 Equilibrium in the product market The aggregate demand function expresses total planned spending as a function of the level of income or output (recall that they are equivalent). The economy will be in equilibrium when the firms have collectively chosen to produce the level of output that exactly corresponds to the level of demand...
eBook - ePubEconomics for Investment Decision Makers
Micro, Macro, and International Economics
- Christopher D. Piros, Jerald E. Pinto(Authors)
- 2013(Publication Date)
- Wiley(Publisher)
...Increasing output also takes time after the downsizing during the recession. 2.2.3. Consumer Behavior As the largest single sector of almost every developed economy (70 percent of the U.S. economy), patterns of household consumption determine overall economic direction more than any other sector. Patterns of consumption are critical to practitioners who, for any number of diverse reasons, have a particular interest in the sector. For example, marketers or equity analysts covering consumer product companies would have a high interest in the sector. The two primary measures of household consumption are retail sales and, where available, a broad-based indicator of consumer spending that also includes purchases outside purely retail establishments, such as utilities, household services, and so on. Often these are presented in nominal terms and deflated to indicate directions of real or unit purchases and growth. Some indicators can make much finer distinctions, such as tracking spending, both real and nominal, of the more specific groups of consumer products. The three major divisions are: (1) durable goods, such as autos, appliances, and furniture; (2) nondurable goods, such as food, medicine, cosmetics, and clothing; and (3) services, such as medical treatment, entertainment, communications, and hairdressers. Because durable purchases usually replace items with longer useful lives, households in hard times can postpone such purchases more readily than spending on either services or nondurable goods...
eBook - ePub- Ola Olsson(Author)
- 2013(Publication Date)
- Routledge(Publisher)
...Part III Macroeconomic Policy 11 IS—MP, Aggregate Demand, and Aggregate Supply DOI: 10.4324/9780203139936-14 In this third part of the book, we will now shift our focus in order to analyze the effects of macroeconomic policy. Most of this chapter will be based on the IS—MP model of the goods and money markets. This model is not micro-founded since it is not based on optimizing household behavior. Instead, it follows in the Keynesian tradition of assuming certain behaviors of variables at the macro level. Only the specifications of aggregate supply will rely on micro foundations. The analysis in this chapter is therefore quite different from the analysis in most other chapters. We start off with the traditional Keynesian framework where we discuss aggregate expenditure and multipliers. We then derive the aggregate demand function from equilibria in the goods and money markets. We also elaborate on the properties of the aggregate supply function under varying assumptions of price and wage stability and provide an overview of the Lucas critique of traditional Keynesian economic policy. After that, we present a new model that introduces financial intermediation into the standard IS—MP framework. Finally, we also present some of the main ideas in the so-called new Keynesian paradigm. 11.1 Aggregate Expenditure and the Multiplier The traditional Keynesian model focuses to a great extent on aggregate demand. The typical starting point is an equation describing the user side of the economy. Let total output be Y, then total expenditure in a closed economy model (we assume away exports X and imports M) is E t = C t + I t + G t. In equilibrium, we should have that total expenditure equals total output so that E t = Y t...
