Aggregate Demand

• Aggregate demand is the total amount of planned spending on a country's goods and services at a given price level and in a given time
• Components of AD:

  • Consumer expenditures
  • Investments
  • Government spending
  • Net exports
• Formula:

  AD= C+I+G+NX

  Aggregate demand= consumption+ investments+ government spending+ net exports
• Consumer expenditure:

  • Household spending
  • Largest component of AD (for most countries). Approximately 65% of AD for the UK.
• Influences on how much households spend:

  • real disposable income
  • consumer confidence and expectations
  • interest rates
  • unemployment/job security
  • wealth
• Real is when inflation has been taken into account (constant prices)
• Disposable income is after taxes and benifits
• Discretionary income is after taxes, benifits and bills have been payed
• Consumer confidence and expectations:

  • Confidence based on job security
  • Confidence in the economy
  • Expectations on how the economy is going to grow
  • Expectation of how prices are going to increase (inflation)
• Income is the flow of money going to factors of production

  • Wages and salaries from jobs
  • Rental income from properties
  • Interest from savings
• Wealth is the current value of a stock of assets owned by someone or society as a whole.

  • Savings in bank accounts
  • Ownership of property
  • Shares/Stocks
• Average propensity to consume measures the proportion of income that is spent rather than saved
• Marginal propensity to consume measures the proportion increased in income that gets spent on consumption
• Average propensity to consume = consumption ÷ income (APC=C/Y)
• Marginal propensity to consume = change in consumption ÷ change in income (MPC=ΔC/ΔY)
• Autonomous consumption is consumer spending needed to meet basic needs irrespective of your level of income

  Gradient = MPC

  
• Savings is when people decide to postpone their consumption until a future time. Savings is disposable income that is not spent.
• Factors affecting household saving:

  • Real interest rate
  • Consumer confidence and expectation
  • Price expectation
  • Taxation of savings
  • Trust in savings institutions
• Price expectation:

  Initially (short-term) may increase spending to purchase at lower price. But with persistent inflation with the expectation of higher prices in the future, households start to look after their money more and spend less for the future.
• Buffer for consumer:

  • Savings can smooth consumption during tough times
  • they allow people to reduce their debt
  • savings are key source of retirement income
• Business survival:

  • Corporate savings provide a cushion during a recession
  • Business savings can be used as finance for takeovers and for capital investment projects
• Investment is the purchase of capital goods (factories, machinery, tools etc) that can be used to produce consumer goods and services. Generally the most volatile. Investment occurs when the expected returns are greater than the costs.
• Gross investment is the total amount the economy spends on new capital goods. But some investments is needed each year to replace warn out machinery.
• Net investments:

  • Gross investments adjusted for capital consumption (deprecation of goods).
  • If net investment is positive then capital stock of a country will increase.
• Influences on investment:

  • Rate of economic growth
  • Current profit levels - state of the economy
  • Business confidence and expectation
  • Animal spirits
  • Capacity utilization - working close to full capacity
  • Corporation tax (profit levels)
  • Interest rates
  • Access to credit
  • Advances in technology
  • Price of capital equipment
  • Influence of government and regulation
• Government spending is spending by the public sector on goods and services such as education, health care and defense.
• Types of government spending:

  • Current
  • Capital
  • Transfer payment
• Current:

  • Spending used to provide public services such as wages or raw materials.
  • Teachers or nurses wages
  • Drugs used in health care
• Capital:

  • Spending on new public infrastructure. It's long term spending.
  • New motorways, school or hospitals
  • New hospital equipment
  • Extra defense equipment
• Transfer payment:

  • Benefits including universal credit, child benefit, disability benefit
  • State pension
  • No output is attached to the payment so its not included in the government spending of aggregate demand
• Influences on government spending:

  • Level of state intervention - size of public sector
  • Level of economic activity - boom or recession
  • Fiscal policy - if aim to stimulate the economy then government spending may increase
  • Make electorate happy
  • War