Aggregate Demand (AD) (AQA A Level Economics)

An Introduction to Aggregate Demand

• Aggregate demand (AD) is the total demand for all goods and services in an economy at any given average price level
  

• Its value is often calculated using the expenditure approach

  • AD = Consumption (C) + Investment (I) + Government spending (G) + (Exports-Imports) (X-M)

  • AD = C + I + G + (X-M)

• Consumption is the total spending on goods and services by consumers (households) in an economy

• Investment is the total spending on capital goods by firms

• Government spending is the total spending by the government in the economy

  • Includes public sector salaries, payments for provision of merit and public goods etc.

  • It does not include transfer payments

• Net exports are the difference between the revenue gained from selling goods or services abroad and the expenditure on goods or services from abroad

  • Individuals, firms and governments export and import

• The relationship between the average price level and the total output in an economy is shown with an aggregate demand (AD) curve

Diagram: Aggregate Demand (AD) Curve for an Economy 

Movements Along the Aggregate Demand Curve

• Whenever there is a change in the average price level (AP) in an economy, there is a movement along the aggregate demand (AD) curve

Diagram: An Increase & Decrease in the Average Price Level (AP)  

Diagram Analysis

• An increase in the AP (ceteris paribus) from AP₁ → AP₂ leads to a movement along the AD curve from A → B

  • There is a contraction of real GDP from Y₁ → Y₂
    
    

• A decrease in the AP (ceteris paribus) from AP₁ → AP₃ leads to a movement along the AD curve from A → C

  • There is an expansion of real GDP (output) from Y₁ → Y₃

Factors that Cause the Entire AD Curve to Shift

• Whenever there is a change in any of the determinants of aggregate demand    (AD) in an economy, there is a shift of the entire AD curve

Diagram: Shift in Aggregate Demand (AD)

Diagram analysis

• An increase in any one of the determinants of aggregate demand (AD) results in a shift right of the entire curve from AD₁ → AD₂

  • At every price level, real GDP has increased from Y₁ → Y₂
     

• A decrease in any one of the determinants of AD results in a shift left of the entire curve from AD₁ → AD₃

  • At every price level, real GDP has decreased from Y₁ → Y₃

The Determinants of Aggregate Demand

• AD = Consumption (C) + investment (I) + Government Spending (G) + (Exports (X) - Imports (M))
   

• Each of these components are influenced by a range of factors and any change to one of them has the potential to shift the aggregate demand curve
   

• If numerous factors change at the same time, the net effect will determine which way—and how far—the aggregate demand shifts

Diagram: Factors that Affect each Determinant

When multiple factors change at the same time, the net effect will determine which way the AD curve shifts—and how far. It is easier to analyse the impact of a single change

The determinants of consumption

• Consumption is the total spending on goods and services by consumers (households) in an economy
  

• The level of disposable income that households have impacts the level of consumption

  • Consumption increases as disposable income increases

  • Consumption decreases as disposable income decreases

Factors that Cause a Change in the Level of Consumption

The determinants of investment 

• Investment is the total spending on capital goods by firms 

• Investment helps to increase the capacity (production possibilities) of an economy

  • Increased capacity = increased potential economic growth 

The Factors that cause a Change in the Level of Consumption

The determinants of government spending

• The level of government spending is influenced by the economic cycle, the political agenda, and the planned level of capital spending 

The Factors that Influence Government Spending

The determinants of net exports 

• The net trade balance is the difference between the value of the exports and imports (X-M)

• The net trade balance is influenced by changes to real income, exchange rates, and the degree of protectionism

Factors Impacting Exports & Imports