Aggregate Demand

Define aggregate demandExplain the determinants of aggregate demand

Introduction to Aggregate Demand

Aggregate Demand: The total demand for a nation’s goods and services in a period of time at a range of price levels.

Introduction to Aggregate Demand

Components of aggregate demand: (Consumers of a nations output)

C: Households, demand goods and services for Consumption.

I: Firms, who demand capital goods, in which they invest. G: Government, which spends on public goods and services. Xn: Export income from abroad, Expenditure from abroad (export) minus Expenditure on imports.

Total Aggregate Demand C + I + G + Xn

• Level of household income. At higher incomes, consumption rises, and at lower incomes, consumption decreases.

• Wealth: value of a households assets minus its liabilities. If wealth rises, households feel richer and consume more. If wealth declines, households feel poorer and consume less.

• Real interest rates: If interest rates are higher, households will prefer to save more and consume less. At lower interest rate, consumption is higher, and savings is less.

• Household debt: At high debt levels, households must allocate more income to paying off debts, therefore consumption falls.

• Household confidence: If households are confident about future incomes or employment opportunities, they are likely to spend more now, so consumption will increase.

Determinants of Aggregate DemandHousehold Consumption

Determinants of Aggregate DemandFirms’ Investment

• Real interest rates: At lower interest rates, firms will borrow more money and buy new capital equipment. If interest are higher, firms will invest less.

• Expectations of firms (confidence): If firms are

confident about future business opportunities, higher investment now. If expectations are poor, firms will invest less now.

• Fiscal policy: Level of taxation and government spending.

• Government debt: More debt may mean

more government spending in the short-run, but debt must be paid off in the long run, so taxes have to be raised and government spending must fall if there is too much government debt.

Determinants of Aggregate DemandGovernment Spending

• Income of foreign consumers: If foreign incomes rise, demand for exports increase and net exports rise.

• Domestic incomes rise: As domestic households

get richer, they will demand more imports, so net export spending may fall.

• Exchange rates: If the currency gets stronger,

exports will be more expensive to foreign consumers, so net exports will fall. If the currency gets weaker, foreigners will demand more of the country’s goods and net exports will rise.

Determinants of Aggregate DemandNet Export

Aggregate Supply

• Define aggregate supply• Explain the determinants of aggregate

supply• Use AD and AS to analyse changes in

macroeconomic equilibrium

Introduction to Aggregate Supply

Aggregate Supply: A curve representing the volume of good and services produced within the economy at a given price level.

Introduction to Aggregate SupplyShort-Run: The period of time over which the level of wages in a nation are fixed.. Also know as fixed-wage period.

Recessionary Gap: is a situation when the real GDP is lower than the potential GDP at the full employment level.

Introduction to Aggregate SupplyShort Run Aggregate Supply (SRAS) Short run aggregate supply (SRAS): Shows the total planned output when prices in the economy can change but the prices and productivity of all factor inputs e.g. wage rates and the state of technology are held constant.

Determinant of Aggregate Supply (Short Run)

Changes in Business CostChanges in unit labour costs: Unit labour costs are wage costs adjusted for the level of productivity. A rise in unit labour costs might be brought about by firms paying higher wages or a fall in the level of productivity.

Commodity prices: Changes to raw material costs and other components e.g. the prices of oil, copper, rubber, iron ore, aluminium and other inputs will affect a firm’s costs

Exchange rates: Costs might be affected by a change in the exchange rate which causes fluctuations in the prices of imported products. A fall (depreciation) in the exchange rate increases the costs of importing raw materials and component supplies from overseas

Determinant of Aggregate Supply (Short Run)

Changes in Business CostGovernment taxation and subsidies:

An increase in taxes to meet environmental objectives will cause higher costs and an inward shift in the SRAS curveLower duty on petrol and diesel would lower costs and cause an outward shift in SRAS

The price of imports: Cheaper imports from a lower-cost country has the effect of shifting out SRASA reduction in a tariff on imports or an increase in the size of an import quota will also boost the supply available at each price levelThe exchange rate affects how much a business must pay for imported raw materials and components

Introduction to Aggregate SupplyLong-Run: The period of time over which the level of wages in a nation are flexible. In the long-run, wages will adjust to the level of demand in the economy. Also known as the flexible-wage period.

Introduction to Aggregate SupplyLong Run Aggregate Supply (LRAS) Shows total planned output when both prices and average wage rates can change – it is a measure of a country’s potential output and the concept is linked to the production possibility frontier

A Quick Over View

Aggregate SupplyAD Shift to the right

Improvements in productivity and efficiency or an increase in the stock of capital and labour resources cause the LRAS curve to shift out. This is shown in the diagram below.

Determinants of Aggregate SupplyChanges in natural rate of growth of output

• Expanding the labour supply: e.g. by improving work incentives and relaxing controls on inward labour migration. In the long term many countries must find ways of overcoming the effects of an ageing population and a rising ratio of dependents to active workers

Determinants of Aggregate SupplyChanges in natural rate of growth of output

• Incease Productivity of labour: Iinvestment in training of the labour force and improvements in the quality of management of human resources. Productivity can be measured in several ways including output per person employed and output per hour worked.

Determinants of Aggregate SupplyChanges in natural rate of growth of output

• Fiscal policy: Level of taxation and government spending.

• Government debt: More debt may mean

more government spending in the short-run, but debt must be paid off in the long run, so taxes have to be raised and government spending must fall if there is too much government debt.

Determinants of Aggregate SupplyChanges in natural rate of growth of output

Improve mobility of labour to reduce certain types of unemployment for example structural unemployment caused by occupational immobility of labour. If workers have more skills and flexibility, they will find it easier to get work. Conversely when unemployment remains high, the economy loses out on potential output and there is a waste of scarce resourcesExpanding the capital stock – i.e. increase investment and research and developmentIncrease business efficiency by promoting greater competition within marketsStimulate invention and innovation – to promote lower costs and improvements in the dynamic efficiency of markets. Innovation creates new goods and services and encourages investment

• Improved mobility of Labour: Reduce certain types of unemployment for example structural unemployment caused by occupational immobility of labour. If workers have more skills and flexibility, they will find it easier to get work. Conversely when unemployment remains high, the economy loses out on potential output and there is a waste of scarce resources

Determinants of Aggregate SupplyChanges in natural rate of growth of output

• Expanding the capital stock: Increase investment and research and development.

Determinants of Aggregate SupplyChanges in natural rate of growth of output

• Increase business efficiency: Promoting greater competition within markets.

• Stimulate invention and innovation: Promote lower costs and improvements in the dynamic efficiency of markets. Innovation creates new goods and services and encourages investment.