Aggregate Demand (AD)
Definition
The total level of spending in an economy at each GPL.
Aggregate Demand
Formula
AD = C + I + G + (X-M)
where
- C = consumer expenditure
- I = investment expenditure
- G = government expenditure
- X = export expenditure
- M = import expenditure
- (X-M) = net exports
GPL Determinants of AD
- Wealth Effect
- Interest Rate Effect
- International Substitution Effect
Non-GPL Determinants of AD
C component
- Δ in consumer expectations & confidence
- Δ in personal income taxes
- Δ in income distribution
- Δ in interest rates & availability of credit
Non-GPL Determinants of AD
I component
- Δ in interest rates & access to credit
- Δ in firms’ expectations & business confidence
- Δ in corporate income tax rates
- Δ in technology
Non-GPL Determinants of AD
G component
- Δ in economic priorties ie. fiscal policies
- Δ in political priorties
Non-GPL Determinants of AD
(X-M) component
- Δ in national income of a country & its trading partners
- Δ in relative price levels between countries
- Δ in foreign exchange rates
Aggregate Supply (AS)
Definition
The total value of G&S produced & sold by domestic firms within an economy at each GPL.
Non-GPL Determinants of AS
- Δ in price of FOPs
- Δ in quantity of resources
- Δ in technology
- Positive
- Negative
- Δ in governments policies
- Δ in expected rate of inflation
The Multiplier Process
ie. K Process
- Firms experience unplanned rundown in stocks & inventories
- Firms ↑ production by hiring ↑ labour
- Demand for labour ↑
- Income of workers ↑ since they are paid ↑ wages by firms
- [Multiplier Principle] Since one’s spending is another’s income, many rounds of spending & re-spending occurs
- Each round becomes smaller due to leakages through savings, taxes & import expenditure
- Assuming firms have spare capacity & idle resources, AD ↑ mtp.
- RNY ↑ mtp.
- AEG achieved
The Reverse Multiplier Process
ie. Reverse K Process
- AD ↓ through C & I
- Firms experience unplanned buildup of stocks and inventories
- Firms ↓ production by hiring ↓ FOPs including labour
- Demand for labour ↓
- Income of workers ↓ as they are paid ↓ wages by firms
- [Reverse Multiplier Principle] Since one’s cut in spending is another’s loss in income, many rounds of ↓ spending & respending occurs
- Multiple rounds of ↓ job & income losses & induced spending ↓ occurs, each getting smaller
- AD ↓ mtp.
- RNY ↓ mtp.
- AEG not achieved
AS Curve
Criteria for ←/→ vs. ↑/↓ shift
←/→ shift: COP
↑/↓ shift: Quality/ quantity of labour → Productive capacity
