Economics
Determinants of Aggregate Demand
Determinants of aggregate demand refer to the factors that influence the total demand for goods and services within an economy. These determinants include consumption, investment, government spending, and net exports. Changes in these factors can lead to shifts in the aggregate demand curve, impacting overall economic output and employment levels.
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9 Key excerpts on "Determinants of Aggregate Demand"
eBook - PDF- William Boyes, Michael Melvin(Authors)
- 2015(Publication Date)
- Cengage Learning EMEA(Publisher)
In the following section, we look first at the price effects, or movements along an aggregate demand curve. Following that discussion, we focus on the nonprice Determinants of Aggregate Demand. 8-3 The Aggregate Demand Curve When we examined the demand curves in the chapter titled “The Market and Price System,” we divided our study into two parts: the movement along the curve—changes in quantity demanded—and the shifts of the curve—changes in demand. We take the same approach here in examining aggregate demand. We first look at the movements along the aggregate demand curve caused by changes in the price level. We then turn to the nonprice determi-nants of aggregate demand that cause shifts in the curve. 8-3a Why the Aggregate Demand Curve Slopes Downward Aggregate demand curves are downward sloping just like the demand curves for individual goods that were shown in the chapter titled “The Market and Price System,” although for different reasons. Along the demand curve for an individual good, the price of that good changes while the prices of all other goods remain constant. This means that the good in question becomes relatively more or less expensive compared to all other goods in the econ-omy. Consumers tend to substitute a less expensive good for a more expensive good. The effect of this substitution is an inverse relationship between price and quantity demanded. As the price of a good rises, the quantity demanded falls. For the economy as a whole, how-ever, it is not a substitution of a less expensive good for a more expensive good that causes R E C A P 1. 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.
eBook - PDF- Kevin D. Hoover(Author)
- 2011(Publication Date)
- Cambridge University Press(Publisher)
Part VI Aggregate Demand 13 An Introduction to Aggregate Demand The central question of macroeconomics is what determines the level and growth rate of GDP. In Part V we looked at the economy from the side of aggregate sup-ply. How did the producers decide how much to produce? And how did they decide how many workers and how much capital to employ in the process? Of course, pro-ducers can profit only if they are able to sell their output. So in this and the next three chapters, we look at the economy from the side of aggregate demand. How do people decide how much to spend? 13.1 A Simple Model of Aggregate Demand Our objective in this chapter is to understand the general principles gov-erning aggregate demand. The national income and product accounts (see Chapters 2 and 3) provide a good starting point. The accounts must always balance; the four national-income-accounting identities (equations (2.1)– (2.4)) must always hold ex post or in people’s plans. Macroeconomic equilib-rium occurs when they also hold ex ante : everyone’s plans are simultaneously fulfilled. Think back to Chapter 2. The product-expenditure identity (equation 2.1 ) is reproduced here as: Y ≡ C + I + G + NX . (13.1) We can think of Y in the equation as the level of aggregate demand. Our focus will be to explain the different elements on the right-hand side. In this chapter, we take the bird’s-eye view: How do spending plans of the dif-ferent households, firms, the government, and the foreign sector become coordinated? That is, how does the economy reach equilibrium – if in fact it does reach equilibrium? What determines the actual values of GDP and other aggregates in equilibrium? And how does the economy behave away from equilibrium? To keep sight of the big picture, this chapter focuses on how the different elements of aggregate demand interact to determine the 487 488 An Introduction to Aggregate Demand total. In later chapters, we examine each of the different elements in more detail.
eBook - PDF- Manzur Rashid, Peter Antonioni(Authors)
- 2015(Publication Date)
- For Dummies(Publisher)
(To read about aggregate supply (AS), flip to Chapter 8.) We describe the various parts that make up aggregate demand and examine the AD‐curve. Along the way you see why AD increases when the price level falls and how the exchange rate affects a country’s net exports. Although we have to include a fair amount of maths, don’t worry: we lead you through it and explain everything clearly step‐by‐step. Looking into What Everyone Wants: Aggregate Demand Economies run on people, firms and governments requiring and buying things. A need exists (demand) that firms fulfil (supply). Students of micro‑ economics spend time learning about the behaviour of supply and demand in individual markets. (See our other book Microeconomics for Dummies .) 108 Part III: Building a Model of the Economy Students of macroeconomics are interested in the economy as a whole, so the emphasis is on aggregate (that is, total) demand for goods and services and aggregate (total) supply. More specifically, aggregate demand comprises the total demand for goods and services in an economy. Aggregate demand is important because (along with aggregate supply) it determines a country’s GDP and price level (and therefore its inflation rate). Changes in aggregate demand also impact the level of unemployment. Without understanding aggregate demand, policy makers would not stand much of a chance of being able to control the economy. Indeed the main tools that policy makers have at their disposal (monetary and fiscal policy) work by influencing aggregate demand (see Chapters 9–11). 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.
eBook - PDF- Steven A. Greenlaw, David Shapiro, Daniel MacDonald(Authors)
- 2022(Publication Date)
- Openstax(Publisher)
Government spending and tax rate changes can be useful tools to affect aggregate demand. We will discuss these in greater detail in the Government Budgets and Fiscal Policy chapter and The Impacts of Government Borrowing. Other policy tools can shift the aggregate demand curve as well. For example, as we will discuss in the Monetary Policy and Bank Regulation chapter, the Federal Reserve can affect interest rates and credit availability. Higher interest rates tend to discourage borrowing and thus reduce both household spending on big-ticket items like houses and cars and investment spending by business. Conversely, lower interest rates will stimulate consumption and investment demand. Interest rates can also affect exchange rates, which in turn will have effects on the export and import components of aggregate demand. Clarifying the details of these alternative policies and how they affect the components of aggregate demand can wait for The Keynesian Perspective chapter. Here, the key lesson is that a shift of the aggregate demand curve to the right leads to a greater real GDP and to upward pressure on the price level. Conversely, a shift of aggregate demand to the left leads to a lower real GDP and a lower price level. Whether these changes in output and price level are relatively large or relatively small, and how the change in equilibrium relates to potential GDP, depends on whether the shift in the AD curve is happening in the AS curve's relatively flat or relatively steep portion.
eBook - PDF- David Shapiro, Daniel MacDonald, Steven A. Greenlaw(Authors)
- 2022(Publication Date)
- Openstax(Publisher)
The following components comprise aggregate demand: consumption spending (C), investment spending (I), government spending (G), and spending on exports (X) minus imports (M): C + I + G + X – M. CLEAR IT UP 276 11 • The Aggregate Demand/Aggregate Supply Model Access for free at openstax.org FIGURE 11.4 The Aggregate Demand Curve Aggregate demand (AD) slopes down, showing that, as the price level rises, the amount of total spending on domestic goods and services declines. The wealth effect holds that as the price level increases, the buying power of savings that people have stored up in bank accounts and other assets will diminish, eaten away to some extent by inflation. Because a rise in the price level reduces people’s wealth, consumption spending will fall as the price level rises. The interest rate effect is that as prices for outputs rise, the same purchases will take more money or credit to accomplish. This additional demand for money and credit will push interest rates higher. In turn, higher interest rates will reduce borrowing by businesses for investment purposes and reduce borrowing by households for homes and cars—thus reducing consumption and investment spending. The foreign price effect points out that if prices rise in the United States while remaining fixed in other countries, then goods in the United States will be relatively more expensive compared to goods in the rest of the world. U.S. exports will be relatively more expensive, and the quantity of exports sold will fall. U.S. imports from abroad will be relatively cheaper, so the quantity of imports will rise. Thus, a higher domestic price level, relative to price levels in other countries, will reduce net export expenditures. Among economists all three of these effects are controversial, in part because they do not seem to be very large. For this reason, the aggregate demand curve in Figure 11.4 slopes downward fairly steeply.
eBook - PDFEconomics
A Contemporary Introduction
- William A. McEachern(Author)
- 2016(Publication Date)
- Cengage Learning EMEA(Publisher)
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 535 they produce equals aggregate spending, which occurs, again, where real GDP is $17.0 trillion. Given the price level, real GDP demanded is found where the amount people spend equals the amount produced. For a given price level, there is only one point along the aggregate expenditure line at which spending equals real GDP. We have now discussed the forces that determine real GDP demanded for a given price level. In the next section, we examine changes that can alter spending plans. C H E C K P O I N T How does the aggregate expenditure line determine the quantity of aggregate output demanded? 23-5 The Simple Spending Multiplier We just used the aggregate expenditure line to find real GDP demanded for a par- ticular price level. In this section, we continue to assume that the price level stays the same as we trace the effects of other changes that could affect spending plans. Like a stone thrown into a still pond, the effects of any change in spending ripple through the economy, generating changes in aggregate output that could exceed the initial change in spending. 23-5a An Increase in Spending Let’s consider the effect of an increase in one of the components of spending. Suppose that firms become more optimistic about profit prospects and decide to increase their investment from $1.0 trillion to $1.1 trillion per year, other things constant. What happens to real GDP demanded? An instinctive response is to say that real GDP demanded increases by $0.1 trillion as well. The idea of the circular flow is central to an understanding of the adjustment process. Recall that production yields income, which generates spending.
eBook - PDFMacroeconomics
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.
eBook - PDFMacroeconomics
Principles & Policy
- William Baumol, Alan Blinder, John Solow, , William Baumol, Alan Blinder, John Solow(Authors)
- 2019(Publication Date)
- Cengage Learning EMEA(Publisher)
9-2 THE MECHANICS OF INCOME DETERMINATION Our first objective is to determine precisely the equilibrium level of GDP on the demand side. To make the analysis more concrete, we turn to a numerical example. Specifically, we examine the relationship between total spending and GDP in the hypothetical economy we introduced in the last chapter. Columns 1 and 2 of Table 1 repeat the relationship between consumption and GDP that we first encountered in the preceding chapter, showing how consumer spending, C, depends on GDP, which we symbolize by the letter Y. Columns 3 through 5 provide the other three components of total spending—I, G, and X 2 IM—through the simplifying 1 All the models in this book assume, strictly for simplicity, that firms seek constant inventories. Deliberate inven- tory changes are treated in more advanced courses. An Equilibrium is a situation in which there are no inherent forces that produce change. Changes away from an equilibrium position will occur only as a result of “outside events” that disturb the status quo. 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. 172 Part 2 The Macroeconomy: Aggregate Supply and Demand assumptions that each is just a fixed number regard- less of the level of GDP. Specifically, we assume that investment spending is $900 billion, government purchases are $1,300 billion, and net exports are 2$100 billion—meaning that in this hypothetical economy, as in the United States today, imports exceed exports.
eBook - PDF- John Adams, Linda Juleff(Authors)
- 2017(Publication Date)
- Red Globe Press(Publisher)
This effect combined with higher prices must therefore reduce consumer spending and so aggregate demand falls to AD 2 . The amount by which y rises in the first instance and falls in the second depends on the size of the multiplier and on the ability of firms to adjust to increases or decreases in AD in a relatively short period of time. For example, increases in productivity during the period of instability could help to absorb the higher wage costs and so offset the need to raise prices. Unfortunately, not all firms operate in circumstances which make this kind of adjustment possible. ■ ■ ■ Application Exercise ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ Using your knowledge of how national income is likely to react to any given change in autonomous demand undertake the following. Sketch and explain the outcome of the following events: (a) a rise in exports (b) an increase in investment followed by a rise in autonomous imports. Note: Put your answers on separate paper and keep them for future reference. ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ ■ You can by now see that a single economic event, working through the multi-plier effect, can have both positive and negative effects on the value of real national income. Clearly the business sector is not immune from these effects, the economic environment 43 but it is still worthwhile for you to analyse more closely the main connections between business and the economic environment as a whole. Before doing so it is sensible to identify those components of aggregate demand which are likely to exert a rapid and significant effect on business if they were to change. So, which components of aggregate demand will fall into this category? It seems reasonable to suppose that changes in personal consumption will have a rapid and significant effect on business, since a downturn in high street spending is very quickly evident in the build-up of stock at both retail and wholesale centres.
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