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Aggregate demand (AD) - Coggle Diagram
Aggregate demand (AD)
Injections and Leakages
Consumption
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The most important factor influencing the level of consumption is income. Economies with higher incomes tend to consume more. Hence, if a person's income rises over time, their consumption tends to rise too.
The concern I with the proportion of total income that is spent on consumption, called the average propensity to consume (APC), and the proportion of total income that is saved, called the average propensity to save (APS). The three greatest influences on the APC are consumer expectations, the level of interest rates and the distribution of income.
is an important determinant of the level of economic growth because consumption by households typically makes up around 55-60% of expenditure (or aggregate demand) in the economy
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Level of interest rates
Increases in the general level of interest rates discourages individual spending (as the cost of borrowing money is now higher) and therefore encourage them to save, while a decrease in interest rates would encourage spending and discourage saving.
Distribution of Income
The more equitable the distribution of an income, the higher the rate of overall spending, and vice versa for a more inequitable distribution of income. This is because people on lower incomes tend to spend proportionately more of their income than those on higher incomes.
This reflects the Keynesian consumption function: the more income that an individual receives, the higher proportion they save and the lower proportion they spend. As a result, policy changes which redistribute income from higher to lower income earners, are more likely to increase consumer spending than policy changes which increase the income of high-income earners (e.g., reduction in top marginal tax rate).
Influences
Business investment is one of the most volatile components of demand or aggregate expenditure, usually contributing between 10 and 15 per cent. The main factors influencing business investment are the cost of capital equipment and business expectations.
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Contractions
Contractions in the economy can be explained by aggregate demand. This is because it is directly related to spending, saving, and consumption which is reflected in the economic cycle.
Expansions
Aggregate demand helps explain why there are expansions in the economy. This is because it is directly related to spending, saving, and consumption which is reflected in the economic cycle.
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