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Components of Aggregate Demand, IMG_F144DD654555-1 - Coggle Diagram
Components of Aggregate Demand
Government Expenditure
Expansionary fiscal policy, usually enacted in response to recessions or employment shocks, increases government spending in areas such as infrastructure, education, and unemployment benefits.
It increases aggregate demand [AD curve shifts to the right] by cutting taxes and increasing government spending. Both provide more money to consumers and businesses, allowing them to purchase and invest.
Government spending is an important part of the economy but excess government spending can lead to inflation in the economy as the buying power of money falls.
https://www.imf.org/en/News/Articles/2021/07/01/na070121-boosting-the-economy-the-impact-of-us-government-spending-plans
The USA has planned to increase spending for American families and jobs by 4.3bn USD. This is expected to bring a cumulative 5.3% addition to the GDP
[Ahmedabad Metro Rail project](
https://allgujaratnews.in/en/modi-is-putting-ahmedabad-metro-in-loss-for-20-years/
The project is now likely to be completed in 2025 for Rs 30 thousand crore. That increases the govt. expenditure and thus increases aggregate demand.
Investment Expenditure
interest rates
inverse relationship. if interest rates fall and people borrow more. money is to be borrowed, increase in cost of borrowing will lead to decrease in investment. AD will fall [leftward shift].
corporate taxes / business taxes
if govt. increases business taxes the it will reduce post tax profits so the firm will have less money to invest to AD will fall.
RLE- US govt., increased corporate taxes, reduced amount of profit for the companies, so investments will reduce.
technological changes
to keep up with advances in technology, companies use more money in investments, so AD increases.
changes in business confidence
more confident in the future of the economy, expect consumer demand to rise, they will be ready to reciprocate and invest more. AD rises.
corporate indebtedness
high level of indebtedness, will decrease the amount of investments.
Consumer Expenditure
factors that affect consumption are changes in income tax, interest rate, level of household debt, wealth, and consumer confidence.
income tax
tax on the income earned. income tax will increase, disposable income will reduce and consumption will reduce. therefore, aggregate demand will decrease.
level of household debt
the easier it is to borrow money, the level of debt will increase. spending power will be restricted. RLE, during the pandemic, the government lowered the interest rates, and the level of indebtedness increased. Consumers will spend less. AD will fall.
wealth
if wealth decreases, consumption will decrease and so will aggregate demand. RLE, millionaire tax in Massachusetts. taxes on wealth generated.
consumer confidence
if consumer confidence is low, aggregate demand will decrease.
RLE, 8.6% inflation in the US. people were buying less groceries due to less consumer confidence.
interest rates
interest rates increase. savings increase. disposable income will decrease. consumer spending will decrease. thus, AD will decrease.
Net Exports
inflation
higher inflation, exports will reduce due to higher costs they pose for the firms. so aggregate demand will fall. [exports of goods with inelastic demand will not fall] inflation and exports have inverse relationship.
exchange rate
currency value decreases, price of exported goods will fall, so demand will rise.exports will increase and AD will rise.
if currency value increases, exports will decrease so AD will fall.
exchange rate and exports have an inverse relationship.
trade policy
tariffs- taxes on quantity. exports may reduce . AD will fall. If trade If the policies are becoming better [eg- free trade], exports will increase. AD will rise.
GDP
if gdp of foreign countries increase, their consumer expenditure will increase and our exports will increase. AD increases.
