1.2 Aggregate Demand

• Aggregate demand:

  Total level of planned real expenditure on goods and services produced within a country​ in a given time period.
• Consumption (C)

  Spending by households on goods and services, with the exception of purchases of new housing. Approximately 66% of GDP.
• Investment (I):

  Spending by firms on goods and services to be used in future production. Approximately 18% of GDP.
• Government expenditure (G):

  Spending by central government and local authorities on the provision of goods and services. Note that spending on transfer payments (welfare benefits) is not part of AD since no output is provided in return. Approximately 20% of GDP.
• Net export (X-M):

  Difference in value between exports and imports. Approximately -4% of GDP.
• The relationship between AD and the price level:

  There is an inverse relationship. If the price level increases then AD falls.
• Causes of shifts in AD:

  1. Changes in consumption

  2. Changes in investment

  3. Changes in government expenditure

  4. Changes in net exports
• Determinants of Consumption:

  1. Disposable income

  2. Interest rates

  3. Confidence

  4. Asset prices

  5. Household debt/savings
• Determinants of investment:

  1. Profits

  2. Interest rates

  3. Confidence

  4. Spare capacity

  5. Competition

  6. Price of capital
• Determinants of government expenditure:

  1. Tax revenue

  2. Budget position

  3. Debt burden
• Determinants of net exports:

  1. Exchange rates

  2. Global demand

  3. Relative inflation rate

  4. Protectionism
• The marginal propensity to consume:

  The willingness of a household to spend any extra income​.
• The relationship between income and consumption depends upon:

  1. The overall level of income of a household

  2. The type of employment e.g. the effects of zero hours contracts?

  3. The level of increase of income

  4. Confidence in the future/economy

  5. Other macroeconomic factors e.g. inflation
• The role of expectations:

  They play a key role in the economy because most economic agents make decisions based on what they think is going to happen in the future.