Explain what is meant by the term ‘Aggregate Demand’? (6)
The term ‘Aggregate Demand’ (AD) means the total amount of planned spending on goods and services at any price level in an economy.
AD is made up of the following components: -
C + I + G + (X - M)
Therefore, it is the total of Consumption (C), Investment (I), Government spending (G) and the difference between Exports (E) and Imports (M). Consumption is spending by households on goods and services and it is the main component of AD (about 65%) For example, it records how much individuals spend on food and clothes. The main determinants of consumption are Interest rates (the cost of credit)
Wealth effects (e.g. an increase in share or house prices means households are willing and able to spend more) The level of employment and wage rates (the higher the level of employment, the more will be spent in the country). Investment is defined as an increase in capital stock. The main influences are Interest rates (if interest rates rise, investment tends to fall because it costs more to borrow the money in order to invest) Confidence levels (if firms think that they will sell more in the future, they are more likely to invest today) Risk (the higher the risk, the lower the level of investment) Government decisions (if the government decides to cut corporation tax (a tax on profit) then firms are more likely to invest) Government bureaucracy (If the government relaxes planning restrictions, firms are more likely to invest in building projects). Government expenditure - Governments can choose to some extent how much they spend and deliberately manipulate total spending in the economy by changing their own level of spending. This is called ‘discretionary fiscal policy’. The government does not have to ‘balance its books’ in the short run so that it can spend more or less than it earns in taxation. If the government spends more than it earns, this is known as fiscal or budget...
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