Study notes

Components of Aggregate Demand

  • Levels: AS, A Level, IB
  • Exam boards: AQA, Edexcel, OCR, IB, Eduqas, WJEC

Aggregate Demand (AD) = total planned real expenditure on a country’s goods and services produced within an economy in each time period.

The components of aggregate demand (AD)

The components of aggregate demand are:

  • Household spending on goods and services (C)
  • Gross Fixed Capital Investment Spending and the Value of the Change in Stocks (I)
  • Government Spending on Public Services (G)
  • Exports of Goods and Services (X)
  • (minus) Imports of Goods and Services (M)

Components of aggregate demand in the UK in 2019

  • Household consumption is the largest element of expenditure across the UK economy, accounting for 63% of the total in 2017.
  • Government consumption accounted for 18% and investment for 17%.

C: Consumers' expenditure on goods and services: Also known as consumption, this includes demand for durables e.g. audio-visual equipment and vehicles & non-durable goods such as food and drinks which are “consumed” and must be re-purchased.

I: Capital Investment – This is spending on capital goods such as plant and equipment and new buildings to produce more consumer goods in the future. Investment includes spending on working capital such as stocks of finished and semi-finished goods

A small part of investment spending is the change in the value of stocks. Producers may find either than demand is running higher than output (i.e. stocks will fall) or that demand is weaker than expected and below current output (in which case the value of stocks will rise.)

G: Government Spending – This is spending on state-provided goods and services including public goods and merit goods. Decisions on how much the government will spend each year are affected by developments in the economy and the political priorities of the government.

Government spending on goods and services is around 18-20% of GDP but this tends to understate the true size of the government sector in the economy. Firstly some spending is on investment and a sizeable amount goes on welfare state payments.

Transfer payments in the form of benefits (e.g. state pensions and the job-seekers allowance) are not included in current government spending because they are a transfer from one group (i.e. people paying income taxes) to another (i.e. pensioners drawing their state pension having retired, or families on low incomes).

X: Exports of goods and services - Exports sold overseas are an inflow of demand (an injection) into our circular flow of income and spending adding to aggregate demand.

M: Imports of goods and services. Imports are a withdrawal of demand (a leakage) from the circular flow of income and spending.

Net exports measure the value of exports minus the value of imports. When net exports are positive, there is a trade surplus (adding to AD); when net exports are negative, there is a trade deficit (reducing AD). The UK has been running a large trade deficit for several years now.

What is the formula for calculating aggregate demand?

The formula for aggregate demand is expressed as: AD = C+I+G+(X-M)

Where:

C+I+G = domestic demand

(X-M) = net exports (or the trade balance)

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