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Aggregate Demand (AD) is the total planned expenditure on goods and services produced in the UK.
Why does AD slope down?
As the price level decreases, consumers can buy more goods and services. So real GDP
As the price level falls, interest rates will fall, so the cost of the borrowing falls, so firms will
invest more so real GDP increases.
As the price level decreases, imports will decease and exports will increase, so real GDP
AD = C + I + G + (X M)
Consumption (C) = Consumption is total consumer expenditure on durable goods (electrical goods),
non-durable goods (food) and services (banking).
What is the Marginal Propensity to Consume (MPC)?
How much of each addition to income is used on consumption. If MPC = 0.9, 90% of your additional
income is used to consumption.
How do firms decide how much to invest?
1. Current production: if a firm is producing at its maximum then it must invest to produce
2. Expectations for the future.
Government Spending (G) = Government spending is the expenditure by the government on goods
and services (education, health and the infrastructure).
Exports minus Imports (X-M) = Exports are UK goods sold to foreign consumers. Imports are
foreign goods brought by UK goods. Exports minus imports are net exports, the difference between
exports and imports.
Factors influencing the components of AD
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Income: An increase in income means consumers can buy more goods and services so C
2. Tax: An increase in volume tax means consumers have less money to spend so C decreases.
3. Expectations: As consumers' expectations rise, they exert more income in the future so save
less and get into more debt and spend more so C increases.
4. Interest Rate: if the interest rate goes down, the cost of borrowing decreases, consumers
will borrow more so C decreases.
Here's a taster:
A reduction in the rate of interest. Interest rates decrease so loans are cheaper, G and I
increases so AD increases and shifts right.
2. A rise in expected profits. Firms expect more profit in the future, so I increases and AD shifts
3. A recession. Incomes are decreased so C decreases, profits decrease, so I decreases, and so
AD shifts left.
4. A fall in house and share prices.…read more