Aggregate Demand

Aggregate Demand

1. Total demand in the economy. It measures spending on goods and services by consumers, firms, the government and overseas consumers and firms.

   • C + I + G +(X-M)

2. Shifts in AD: Consumer Confidence, Interest Rate, Taxes, Gov.t Spending, Exchange Rate, Availability of Credit, House prices(wealth effect)

3. Consumption

   • How much consumers spend on goods and services, largest component AD accounts for 60% AD.
     • Disposable income: amount of income consumers have left over after taxes and social security charges have been removed.
       • Consumer income comes from wages/pensions/savings/benefits/investment (dividend payments
   • Marginal Propensity to Consume = how much a consumer changes their spending following a change in income. Whatever not spent is saved.
     • Influences on Consumption
       • Interest Rates - If lower = cheaper borrowing and reduced incentive to save therefore spending and investment increases. Increase interest rate = reduced cost of debt e.g. mortgages.
         • However, Time lags between change in interest rate and rise in AD therefore not useful for quick increases AD.
         • Consumer Confidence - high = invest and spend more, feel they will get a higher return on them. Affected by anticipated income and inflation. Fear unemployment/high taxes = spend less and save more. Delays large purchases e.g mortgages.
           • Wealth Effect - UK - people own houses, increased price = feel more wealthy therefore spend more. Housing equity - difference between market value and remaining debt. House price increase = rise in equity therefore feel wealthy and spend more
     • Marginal Propensity to Save = proportion of each additional pound of household income that is used for saving. MPC + MPS = 1.