AGGREGATE DEMAND AND AGGREGATE DEMAND CURVE

The aggregate demand is the total demand for final goods and services in a country for a given period.

It is the total demand for a country's goods and services at different price levels.

The aggregate demand consist of four components namely; consumption, investment, Government expenditure and Net export.

1. Consumption: This consists of the total household demand for final goods and services in a country.

Consumption is usually determined by the consumption function and is usually the largest component of the aggregate demand of an economy.

It is important to note here that household expenditure on housing is not included in consumption demand. Rather, it is included in the investment demand 

2. Investment: This is the total spending by the business on the purchase of capital goods in an economy.

As we noted earlier, household spending on housing and other residential structures are included in the investment demand

3. Government expenditure: This is the total spending by the government on final goods and services in a country.

4. Net export: This is simply the total foreign spending on goods and services.

It is simply the difference between foreign demand for our goods and services (export) and local demand for foreign goods (import).

Aggregate is, therefore, the demand for the Gross domestic product (GDP) of an economy.

If we were to represent this statement mathematically, it will be like this:

AD=C+I+G+(X-M)

Aggregate Demand Curve

An aggregate demand curve shows the inverse relationship between the price level and the aggregate demand for a country's real GDP. 

Generally, a change in the price level will cause a movement along the same aggregate demand curve.

Aggregate demand curve
Image credit: Macroeconomics: a European perspective 

If the change is a rise in the price level, then there will be a contraction in aggregate demand 

Conversely, a fall in the price level of goods will cause an extension in aggregate demand.

But, why does aggregate demand falls when the price level rises and rises when the price level falls? 

There are three reasons for this: wealth effect, interest-rate effect, and foreign trade effect. We discussed these reasons here.

Like the normal demand for goods and services, Aggregate demand does shift.

Generally, a non-price level will cause a shift in the aggregate demand curve.

But, what are these non-price factors that shift aggregate demand?

Because aggregate demand is made up of consumption, investment, government spending, and net export, therefore, any non-price level factors that affect these four main components will cause a shift in aggregate demand.

Let's look at some factors that can cause a shift in aggregate demand.

Factors That Shift The Aggregate Demand

1. Consumer confidence: Consumer confidence is described by how optimistic consumers are about the economy as a whole and their financial status.

Generally, if consumers are optimistic about the economy and their financial status, they tend to spend rather than save. This will increase consumer spending which will increase aggregate demand.

On the contrary, if consumers are pessimistic about the economy and their financial situation, they tend to save rather than spend. This will decrease consumer spending which will also decrease aggregate demand.

2. Business confidence: This describes firms' future expectations about the economy 

Generally, when firms expect the economy to contract, they decrease investment, which decreases aggregate demand.

By contrast, firms will increase investment if they expect the economy to expand. The result is that aggregate demand increases.

3. Tax: As everyone knows, taxes are mandatory financial taxes imposed on taxpayers like individuals and the government.

While personal taxes are imposed on individuals or households, corporate taxes are imposed on businesses.

Generally, a rise in personal tax will reduce aggregate demand because consumers now have less to expend on goods and services.

Conversely, a reduction in personal tax would increase aggregate demand as consumers now have more income to expend on goods and services which would 

As it relates to business, an increase in corporate tax will reduce aggregate demand because aggregate  business spending on capital stocks  (investment) decreases

By the same reasoning, a reduction in corporate tax will increase aggregate demand because aggregate business spending on capital stock increases

4. Fiscal policy: This is government policy relating to the use of tax and its spending level.

When government expands its fiscal policy, aggregate demand increases.

The reverse is also true. When the government engages in contractionary fiscal policy, aggregate demand falls.

5. Monetary policy: This is government policy relating to the use of money to affect economic activity in the country.

When the government engages in expansionary monetary policy, the money supply increases which reduces interest rates.

The result is that aggregate demand will increase because the investment will increase due to a decrease in interest rates.

By the same logic, A contractionary monetary policy will decrease aggregate demand.

6. Exchange rate: This is the rate at which one country's currency will exchange for another.

Generally, A fall In the value of a country's currency will make its export cheaper. This increases export while also increasing aggregate demand.

Conversely, a rise in the value of a country's currency will make its export more expensive, which results in a decrease in aggregate demand.

Therefore, these seven factors cause a shift in aggregate demand. 

If any of the aforementioned factors increases aggregate demand,  then the aggregate curve will shift to the right (from AD to AD1)


Shift in aggregate demand

Conversely, if any of the factors decrease aggregate demand, then aggregate demand will shift to the left (from AD to AD1)

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