Components of Aggregate Demand

10 Key excerpts on "Components of Aggregate Demand"

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  eBook - PDF

  Macroeconomics For Dummies, UK Edition

  • Manzur Rashid, Peter Antonioni(Authors)
  • 2015(Publication Date)
  • For Dummies

    (Publisher)

  Meeting the Components of Aggregate Demand Economists conveniently break aggregate demand down into four different components: ▶ ✓ Consumption ( C ): Household demand for goods and services. ▶ ✓ Investment ( I ): Firm demand for capital goods but also household demand for new housing. ▶ ✓ Government purchases ( G ): Government demand for goods and services. ▶ ✓ Net exports ( NX ): The demand of people living abroad for goods and services produced domestically, less domestic demand for foreign goods. That is, net exports ( NX ) = exports ( X ) – imports ( M ). Adding all these components together gives total expenditure on goods and services. Now, the total expenditure on goods and services must equal total output or GDP ( Y ), and so the components of AD must add up to equal Y : Y C I G NX Or equivalently Y C I G X M 109 Chapter 7: Working Out a Country’s Economic Demand Tucking in! Consumption Consumption ( C ) is the largest component of aggregate demand: in the UK it accounts for some two‐thirds of output. In other words, around 60 per cent of everything produced in the UK ends up being consumed by households in one way or another. So whether you’re slurping a soft drink, chomping on a chocolate bar or even gobbling some grapes, you’re contributing to the coun‑ try’s consumption. Consumption doesn’t just include things you literally consume such as food and drink (and, if you’re Homer Simpson, flowers!): all goods and services that households purchase are included in consumption. So the flat‐screen TV you got for Christmas is consumption.

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  Macroeconomics

  Principles and Policy

  • William Baumol, Alan Blinder(Authors)
  • 2015(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  Swings in investment spending are even more difficult to predict, partly because they are tied so closely to business confidence and expectations. Developments abroad also often lead to surprises in the net export account. Even the final component of aggre-gate demand, government purchases ( G ), is subject both to the vagaries of politics and to sudden military and national security events such as 9/11 and the wars in Iraq and Afghanistan. We could say much more about the determinants of aggregate demand, but it is best to leave the rest to more advanced courses—for we are now ready to apply our knowledge of aggregate demand to the construction of the first model of the economy. Although it is true that income determines consumption, the consumption function in turn helps to determine the level of income. If that sounds like circular reasoning, read the next chapter! Copyright 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Chapter 8 Aggregate Demand and the Powerful Consumer 161 1. Aggregate demand is the total volume of goods and services purchased by consumers, businesses, gov-ernment units, and foreigners. It can be expressed as the sum C I G I ( ) X I M X , where C is consumer spending , I is investment spending , G is government purchases , and X IM is net exports. 2. Aggregate demand is a schedule: The aggregate quan-tity demanded depends on (among other things) the price level. But, for any given price level, aggregate demand is a number.

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  Economics

  A Contemporary Introduction

  • William A. McEachern(Author)
  • 2016(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Chapter 23 Aggregate Demand 531 entire year. For example, because the recession of 2001 lasted only eight months, GDP managed a small gain for the year of 1.0 percent and consumption grew 2.6 percent. It was the 6.1 percent drop in investment that caused the recession. That’s why economic forecasters pay special attention to business expectations and investment plans. Sources: Economic Report of the President, February 2015; Survey of Current Business 95, various months for 2015; and OECD Economic Outlook 97 (May 2015). For data and articles about economic aggregates, go to the Bureau of Economic Analysis site at http://bea.gov/. ©LuckyImages/Shutterstock.com 23-3b Government Purchases The third component of aggregate expenditure is government purchases of goods and services. Federal, state, and local governments buy thousands of goods and services, ranging from weapon systems to traffic lights to education. During the most recent decade, government purchases in the United States accounted for 20 percent of GDP, most of that by state and local governments. Decisions about government purchases are largely under the control of public officials, such as the decision to build an interstate highway, boost military spending, or hire more teachers. These spending decisions do not depend directly on income in the economy. We therefore assume that government purchases are independent of income.

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  Macroeconomics

  A Contemporary Introduction

  • William A. McEachern(Author)
  • 2016(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Chapter 9 Aggregate Demand 199 entire year. For example, because the recession of 2001 lasted only eight months, GDP managed a small gain for the year of 1.0 percent and consumption grew 2.6 percent. It was the 6.1 percent drop in investment that caused the recession. That’s why economic forecasters pay special attention to business expectations and investment plans. Sources: Economic Report of the President, February 2015; Survey of Current Business 95, various months for 2015; and OECD Economic Outlook 97 (May 2015). For data and articles about economic aggregates, go to the Bureau of Economic Analysis site at http://bea.gov/. ©LuckyImages/Shutterstock.com 9-3b Government Purchases The third component of aggregate expenditure is government purchases of goods and services. Federal, state, and local governments buy thousands of goods and services, ranging from weapon systems to traffic lights to education. During the most recent decade, government purchases in the United States accounted for 20 percent of GDP, most of that by state and local governments. Decisions about government purchases are largely under the control of public officials, such as the decision to build an interstate highway, boost military spending, or hire more teachers. These spending decisions do not depend directly on income in the economy. We therefore assume that government purchases are independent of income. As noted earlier, government purchases represent only one of the two government outlays; the other is transfer payments, such as for Social Security, welfare benefits, and unemployment insurance.

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  Macroeconomics

  • William Boyes, Michael Melvin(Authors)
  • 2015(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  Aggregate expenditures are the sum of consumption, investment, government spending, and net exports. 2. Consumption depends on household income, wealth, expectations, demographics, and taxation. 3. Investment depends on the interest rate, technology, the cost of capital goods, and capacity utilization. 4. Government spending is determined independent of current income. 5. Net exports depend on foreign and domestic incomes, prices, government policies, and exchange rates. Chapter 8 Macroeconomic Equilibrium: Aggregate Demand and Supply 151 Copyright 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. the demand curve to slope down. Instead, the aggregate quantity demanded, or total spend-ing, will change as the price level changes as a result of the wealth effect, the interest rate effect, and the international trade effect of a price-level change on aggregate expenditures. We will discuss each of these effects in turn. 8-3a-1 The Wealth Effect Individuals and businesses own money, stocks, bonds, and other financial assets. The purchasing power of these assets is the quantity of goods and services for which the assets can be exchanged. When the level of prices falls, the purchasing power of these assets increases, allowing households and businesses to purchase more. When prices go up, the purchasing power of financial assets falls, causing households and busi-nesses to spend less. This is the wealth effect (sometimes called the real-balance effect ) of a price change: a change in the real value of wealth that causes spending to change when the level of prices changes.

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  Managerial Economics for Decision Making

  • John Adams, Linda Juleff(Authors)
  • 2017(Publication Date)
  • Red Globe Press

    (Publisher)

  Thus, as we said earlier, aggregate demand is identical to national income which is identical to national expenditure. The Components of Aggregate Demand are what goes into the calculation of an economy’s national accounts every year. In the next section we are going to develop a more detailed picture of our simple model of the economic environment. ■ 2.4 Using the Model Before we look at how our simple model of the economic environment tells us how the economy behaves as any single component of aggregate demand changes, we want to introduce a slight complication while we develop a more detailed version of our model so far. The consumption function relates to real disposable national income, but aggregate demand relates to real gross national income. We want to use a single definition of real national income so we have to get rid of one of these. We will retain the gross version since this will allow us to treat taxation separately from consumption. The procedure is quite straightforward – it is just income minus total taxation. That is, yd = y – ty . So, we can take account of this in the consumption function as follows: c = a + b ( y − ty ) [Eq. 2.14] where b is the MPC and t represents the taxation rate. Multiplying out the bracketed term gives: c = a + by − bty [Eq. 2.15] which reads as: consumption equals a basic level plus some proportion of gross real income minus some proportion of gross real income. For example, suppose real national income in 1998 (using 1990 as a base year) is £400 billion, the MPC is 80 per cent (that is, 0.8) and the tax rate is 25 per cent (that is, 0.25) – this includes all allowances and national insurance). Let us also suppose that the basic consumption level a is £60 billion. Then consumption demand, that is, consumer spending, will be: c = 60 + (0.8 * 400) – (0.8 * 0.25) * 400 = 60 + 320 – 0.2 * 400 = 380 – 80 = 300 that is, consumption is £300 billion.

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  Macroeconomics for Business

  The Manager's Way of Understanding the Global Economy

  • Lawrence S. Davidson, Andreas Hauskrecht, Jürgen von Hagen(Authors)
  • 2020(Publication Date)
  • Cambridge University Press

    (Publisher)

  While aggregate demand often drives changes in the economy there are times when aggregate supply gets behind the steering wheel. A complete under- standing of output and prices, therefore, brings together everything impacting aggregate demand and aggregate supply. With this more complete model mastered we can then move on to investigating monetary and fiscal policies in the next chapters. 2.6 REVIEW QUESTIONS 1. Which component of GDP contains sales of new automobiles? Which component includes purchases of new equipment for business firms. Compare and contrast the behaviors of these two components of GDP. 2. Why are changes in inventories included in GDP? 3. Are rising inventories a positive sign for the economic growth of an economy? 4. What is the real interest rate and why is it important to aggregate demand? 5. A rise in the price level is shown as a movement along the AD curve. Why would a rise in the price level reduce aggregate demand? 6. Why should business executives care about monetary policy? 7. Why are governments exposed to very strong opinions about what they should and shouldn’t be doing with AD policy? Review Questions 81 2.7 Appendix: IS–LM Analysis In this appendix, we explain the ideas of sections 2.3.5–2.3.7 further and more precisely. Recall that aggregate demand and its components and aggregate income are defined in real terms, i.e., corrected for price level changes or measured in units of output. Call aggregate income Y, private household consumption expenditures C, private household savings S, government revenues from taxes T, government spending on government consumption and investment G, and gross domestic private investment I. Consider again the equality of aggregate demand and aggre- gate income.

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  Applied Intermediate Macroeconomics

  • Kevin D. Hoover(Author)
  • 2011(Publication Date)
  • Cambridge University Press

    (Publisher)

  Here the increased real rate of interest reduces the level of invest-ment by exactly enough to fund the additional government spending. This phenomenon is sometimes referred to as the crowding out of private spend-ing by government spending. Crowding out is discussed in more detail in Chapter 17. Summary 1. GDP is determined by the interaction of aggregate supply and aggregate demand. The Components of Aggregate Demand are given by the right-hand side of the product-expenditure identity: Y ≡ C + I + G + NX . A theory of aggre-gate demand explains the economic behavior behind each of the components. Equilibrium occurs when the plans of all the economic actors are compatible. 2. Consumption depends on many factors. The consumption function relates con-sumption to its most important determinant – disposable income. The marginal propensity to consume (mpc) is defined as the small increase in saving that results from a small increase in (disposable) income and is the slope of the con-sumption function. The mpc is greater than zero and less than one. In theory, the mpc is less than or equal to the average propensity to consume (apc). 3. Data for the United States suggest that a good approximation of consumption behavior sets the mpc equal to the apc, so that the consumption function passes through the origin. 4. Taxes are generally a function of income. The marginal tax rate is greater than zero and less than one. Data for the United States suggest that a good approxi-mation for the tax function sets the marginal tax rate to a constant equal to the average tax rate. 5. A simple model of aggregate demand substitutes the consumption and tax functions into the national-income-accounting identities. In such a model, an increase in autonomous spending on investment, government goods and ser-vices, or net exports raises GDP by a multiplied amount. The initial spending

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  Macroeconomics

  Principles & Policy

  • William Baumol, Alan Blinder, John Solow, , William Baumol, Alan Blinder, John Solow(Authors)
  • 2019(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  11 In this context, disposable income is national income plus transfer payments minus taxes. 1. Explain the difference between final goods and interme- diate goods. Why is it sometimes difficult to apply this distinction in practice? In this regard, why is the concept of value added useful? 2. Explain the difference between government spending and government purchases of goods and services (G). Which is larger? 3. Explain why national income and gross domestic product would be essentially equal if there were no depreciation. Discussion Questions Copyright 2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. 169 L et’s briefly review where we have just been. In Chapter 5, we learned that the interac- tion of aggregate demand and aggregate supply determines whether the economy will stagnate or prosper, whether our labor and capital resources will be fully employed or substantially unemployed. In Chapter 8, we learned that aggregate demand has four components: consumer expenditure (C), investment (I), government purchases (G), and net exports (X – IM). It is now time to start building a theory that puts the pieces together so we can see where the aggregate demand and aggregate supply curves come from. Because it is best to walk before you try to run, our approach is sequential. We begin in this chapter by assuming that taxes, the price level, the rate of interest, and the international value of the dollar are all constant. None of these assumptions is true, of course, and we will dispense with all of them in subsequent chapters.

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  eBook - ePub

  Macroeconomics

  (With Study Guide CD-ROM)

  • Jagdish Handa(Author)
  • 2010(Publication Date)
  • WSPC

    (Publisher)

  CHAPTER 4 Determinants of Aggregate Demand: The Commodity Market of the Closed Economy

  This chapter presents the analysis of the commodity market of the macroeconomy. For this analysis, it encapsulates the relationships of the commodity market into the IS equation and curve.

   

  Chapter 1 listed four types of goods in the closed economy. These are:

  1. Commodities, usually referred to as goods and services, and including both consumer goods and physical capital 2. Money 3. Bonds (i.e., all non-monetary financial assets) 4. Labor This chapter lays out the assumptions and their implications for the commodities market of the closed economy. It encapsulates this analysis into the compact IS relationship and curve. 4.1 Symbols Used Many of these symbols used in this chapter have already appeared in the preceding chapters. However, for convenience, the meanings of the symbols used in this chapter are specified in Table 4.1.

  In most cases, the small letter symbol will indicate the real value of the variable while the capital one will indicate its nominal (dollar) value. Thus, y is the real value of income/output while Y is its dollar value. One exception to this rule is the use of K to designate the real value of the physical capital stock.

  The superscript d on a variable will indicate its demand and the superscript s will indicate its supply. The variable symbol without either of these superscripts will indicate its actual value. If there exists equilibrium, the actual value will be the equilibrium one, i.e., one at which the demand and supply for that variable are equal. Thus, n d is the demand for labor and n s is its supply, while n is actual employment.

  The symbol ≡ indicates an identity while the symbol = indicates an equilibrium condition. 4.2 The Commodity Sector of the Closed Economy

  As specified in Chapter 1

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