demand (AD) is the total
demand for goods and services produced in the economy over a period of time.
planned expenditure for goods and services in the economy =
+ I + G + (X-M)
Consumers' expenditure on goods
and services: This includes demand for durables & non-durable goods.
Gross Domestic Fixed Capital Formation
- i.e. investment spending by companies on capital goods. Investment also
includes spending on working capital such as stocks of finished goods and
work in progress.
General Government Final Consumption. i.e. Government spending on publicly provided goods and services
including public and merit goods. Transfer payments in the form of social
security benefits (pensions, job-seekers allowance etc.) are not included as
they are not a payment to a factor of production for output produced. A
substantial increase in government spending would be classified as an
expansionary fiscal policy.
Exports of goods and services - Exports sold overseas are an inflow of demand into the circular flow of
income in the economy and add to the demand for UK produced output. When
export sales from the UK are healthy, production in exporting industries will
increase, adding both to national output and also the incomes of those people
who work in these industries.
Imports of goods and services.
Imports are a withdrawal (leakage) from the circular flow of income and
spending in the economy. Goods and services come into the economy - but there
is a flow of money out of the economic system. Therefore spending on imports
is subtracted from the aggregate
demand equation. Note that X-M
is the current account of the balance of payments.
can use a circular flow of income to show the movement of money around an
economy. It is important to
distinguish between the injections and withdrawals in the flow.
Factor payments are received from households in return for use of
factors of production, individually they are called:
Capital – Interest
Enterprise – Profit
Land – Rent
Labour – Wages
Aggregate Demand Curve
demand normally rises as the
price level falls. This can be explained in three main ways:
money balances effect: As the price level falls, the real value of money balances held
increases. This increases the real purchasing power of consumers.
and interest rates: A
lower price level increases the real interest rate - there will be pressure
on the monetary authorities to cut nominal interest rates as the price level
falls. Lower nominal interest rates should encourage an increase in consumer
demand and planned investment.
competitiveness: If the
UK price level is lower than other countries (for a given exchange rate), UK
goods and services will become more competitive. A rise in exports adds to
aggregate demand and therefore boosts national output.
In Aggregate Demand
change in one of the components of aggregate demand will cause a shift in the
aggregate demand curve.
increase in AD (AD1 ®
AD2) may be caused by:
- An increase in export demand causing an injection of foreign demand
into the domestic economy.
- The government may also increase its own expenditure.
- Businesses may raise the level of planned capital investment
decrease in AD (AD2 ®
AD1) may be caused by:
- Consumers feeling wealthier and increasing their consumption.
- Businesses are pessimistic about the future of the economy and
reduce their level of investment.