Aggregate demand (AD) is the total planned spending in an economy. Together with aggregate supply it is the model you'll use for almost every macro question — so…
Aggregate demand (AD) is the total planned spending in an economy. Together with aggregate supply it is the model you'll use for almost every macro question — so get the components and the curve rock-solid.
Learning objectives — by the end of 2.2 you can…
- state the components of AD and draw the AD curve; - explain why AD slopes downward and what shifts it; - analyse the influences on consumption, saving, investment, government spending and net trade.
The AD curve & its components
Spec: 2.2.1
Aggregate demand is the total planned spending on an economy's goods and services at each price level, in a given period. It has four components:
Consumption + Investment + Government spending + (Exports − Imports)
In most economies consumption (C) is the largest component. The AD curve slopes downward: a lower price level raises the real value of wealth and incomes, tends to lower interest rates (boosting borrowing and investment), and makes exports more competitive — so total planned spending rises.
Consumption & saving
Spec: 2.2.2
Consumption (C) is total household spending — usually the biggest slice of AD. What's not consumed out of disposable income is saved, and the savings ratio is the proportion of disposable income that households save.
| Influence on consumption | Effect |
|---|---|
| Disposable income | The main driver — more income, more spending. |
| Interest rates | Higher rates reward saving and raise borrowing costs → less consumption. |
| Consumer confidence | Optimism about jobs/incomes raises spending. |
| Wealth effects | Rising house or share prices make people feel richer → spend more. |
| Availability of credit | Easier borrowing → more spending. |
Investment
Spec: 2.2.3
Investment (I) is spending by firms on capital goods (machinery, buildings, technology). Gross investment is the total; net investment is gross minus depreciation (the wearing-out of existing capital).
| Influence on investment | Effect |
|---|---|
| Rate of economic growth | Faster growth → firms expect higher demand → invest more (the accelerator). |
| Interest rates | Lower rates cut the cost of borrowing to invest. |
| Business confidence | "Animal spirits" — expectations about the future are crucial. |
| Tax on profits | Lower corporation tax leaves more retained profit to invest. |
Governments can encourage investment through tax relief, subsidies and lower corporation tax.
Government spending & net trade
Spec: 2.2.4
Government spending (G) depends on the government's fiscal stance, the level of economic activity (in a recession, benefit spending rises automatically — an "automatic stabiliser"), the need to correct market failures, and political priorities.
Net trade (X − M) is affected by:
2.2 Recap — nail these
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