2.2 Aggregate demand

Aggregate demand consists of Consumption (C), Investment (I), Government spending (G), Exports (X) and Imports (M)

AD = C + I + G + (X – M)

Definition: Aggregate demand is the total demand for goods and services in an economy at different price levels.

Aggregate Demand DiagramExplanation of why AD is downward sloping:

  • As prices rise, demand for economy’s goods and services decreases. Goods become less competitive internationally¬†and people’s real income falls.

AD will shift if any of its components (C, I, G, X, M) change.

Consumption is affected by:

  • Consumer Confidence
  • Interest rates
  • Personal Income taxes
  • Household indebtedness
  • Wealth

Investment is affected by:

  • Interest rates
  • Business confidence
  • Technology
  • Business taxes
  • Level of corporate indebtedness

Government spending is affected by political and economic priorities.

Exports and Imports are affected by:

  • Income of trading partners
  • Exchange rates
  • Changes in the level of protectionism
  • Relative inflation rates

 

Find everything you need to know about aggregate supply here