Aggregate demand

• Aggregate Demand (AD) formula: AD = C + I + G + (X - M)

  • C: Consumption / consumer spending
  • I: Investment
  • G: Government spending
  • X: Exports
  • M: Imports
• Factors affecting Consumption:

  • Disposable income: amount of income consumers have after reduction of taxes, social security charges
  • Interest rates: low rates = cheaper borrowing = low savings, more consumption
  • Consumer confidence: high confidence = more investment = more consumption
• Factors affecting Investment:

  • Rate of economic growth: high rate = more revenue for firms due to high consumer spending = more profit to invest
  • Business confidence: if confident, firms invest more
  • Demand for exports: high demand leads to more investment
• Factors affecting Government spending:

  • Economic growth: in recession, government increases spending to stimulate the economy
• Factors affecting Net trade balance:

  • Real income: in economic growth, consumers have higher incomes = consumption increases = imports increase
• Movements along the Aggregate Demand (AD) curve:

  • Contraction or expansion of AD is caused by a change in price level
  • Rise in price level = contraction of AD
  • Fall in price level = expansion of AD
• Shifts in Aggregate Demand (AD) curve:

  • Shifts occur when one of the components of the formula changes
  • Factors affecting shifts in AD include consumer confidence, business confidence, taxes, interest rates, exchange rate, government spending, wealth effect, and access to credit