Aggregate Demand

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:

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

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.

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).

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:

Real incomes at home (raise imports) and abroad (raise our exports);
The exchange rate — a stronger currency makes exports dearer and imports cheaper, worsening net trade;
The state of the global economy and the degree of protectionism;
Non-price factors such as quality, design and reliability.

2.2 Recap — nail these

AD = C + I + G + (X − M); the curve slopes down; a price-level change is a movement, a component change is a shift.
Consumption depends mainly on disposable income, plus interest rates, confidence, wealth and credit.
Investment depends on growth expectations, interest rates, confidence and profit taxes.
Net trade turns heavily on the exchange rate and relative incomes.