Aggregate demand and aggregate supply and their interaction

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Aggregate demand (AD) - is the total demand for goods and services produced in an economy at a given price level and in a given time period.

Aggregate demand is made up of consumer expenditure (C), investment (I), government spending (G), and net exports, which is exports (X) minus imports (M).

So, AD = C + I + G + (X - M)

Definitions:

Price level - the average of each of the prices of all the products produced in an economy.

Consumer expenditure - spending by households on consumer products.

Investment - spending on capital goods.

Government spending - spending by the central government and local government on goods and services.

Exports - products sold abroad.

Imports - products bought from abroad.

Net exports - the value of exports minus the value of imports.

The components of aggregate demand

Consumer expenditure (consumption) - it is spending by households items such as clothing, food and insurance.

Investment - Most volatile component of aggregate demand. Spending on capital goods, such as delivery vehicles, machines and office buildings.

Government spending - spending by central government and local government on e.g. education, health care and police services.

IT DOES NOT INCLUDE TRANSFER PAYMENTS SUCH AS HOUSING BENEFIT, JOB SEEKERS ALLOWANCE AND STATE PENSION!

This is because such payment do not involve the government itself buying goods and services. E.G - if government increases job seekers allowance, this would be reflected in higher consumer expenditure.

Net exports - adds foreigners' spending on the country's goods and services and deducts spending by the country's population on imports.

This can make negative/positive contribution to aggregate demand.

A country that has a trade surplus with exports > than imports, then adding net exports to C + I + G will increase aggregate demand.

Existence of trade deficit - aggregate demand would be lower than total domestic demand.

Definition:

Transfer payments - money transferred from one person or group to another not in return for any good or services.

Job seeker's allowance - a benefit paid by the government to those unemployed and trying to find a job.

Trade surplus - the value of exports exceeding the value of imports.

Trade deficit - the value of imports exceeding the value of exports.

Learning tip!!!!

Aggregate demand is planned spending on the products produced by an economy and not planned spending within an economy. So, aggregate demand adds spending on exports and deducts spending on imports. In contrast, planned spending within an economy includes spending on imports but not spending on exports.

Definition

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