2. Aggregate Demand
• Aggregate demand is an economic measurement of the total amount
of demand for all finished goods and services produced in an
economy
• Aggregate demand is expressed as the total amount of money
exchanged for those goods and services at a specific price level and
point in time
• Aggregate demand consists of all consumer goods, capital goods
(factories and equipment), exports, imports, and government
spending.
• Aggregate Demand was Introduced by the Economist “John
Maynard Keynes”
3. History
John Maynard Keynes
• John Maynard Keynes, was an English
economist, whose ideas fundamentally
changed the theory and practice of
macroeconomics and the economic
policies of governments.
• Keynes advocated the use
of fiscal and monetary policies to
mitigate the adverse effects of
economic recessions and depressions.
He detailed these ideas in The General
Theory of Employment, Interest and
Money, published in 1936.
4. Contd..
Keynesian Economics
• Keynesian economics is a macroeconomic economic theory of
total spending in the economy and its effects on output,
employment, and inflation.
• Keynes advocated for increased government expenditures and
lower taxes to stimulate demand and pull the global economy
out of the depression.
• Keynesian economics focuses on using active government
policy to manage aggregate demand in order to address or
prevent economic recessions.
5. Contd..
The Great Depression
• The Great Depression was the greatest and longest economic
recession in modern world history.
• The Great Depression started in the United States after a major
fall in stock prices that began around September 4, 1929, and
became worldwide news with the stock market crash of
October 29, 1929, (known as Black Tuesday).
• The causes for great depression was Bank Failure, Decline of
International trade, Less demand for Agriculture Produce and
industrial goods, Unequal Distribution of wealth.
6. Contd..
• The Great Depression had devastating effects in both rich and
poor countries. Personal income, tax revenue, profits and
prices dropped, while international trade fell by more than
50%. Unemployment in the U.S. rose to 23% and in some
countries rose as high as 33%.
• Cities around the world were hit hard, especially those
dependent on heavy industry.
• Construction was virtually halted in many countries.
• Farming communities and rural areas suffered as crop prices
fell by about 60%.
• Facing decline in demand with few alternative sources of jobs,
areas dependent on primary sector industries suffered the most.
7. Calculating Aggregate Demand
Aggregate Demand= C+I+G+(X-M)
where:
C=Consumer spending on goods and services
I=Private investment and corporate spending on non-
final capital goods (factories, equipment, etc.)
G=Government spending on public goods and social
services (infrastructure, Medicare, etc.)
(X-M):- Exports minus Imports
- The net trade balance
- Trade Surplus (X>M)
- Trade Deficit (X<M)
8. Factors That Can Affect Aggregate
Demand
• Changes in Interest Rates
• Income and Wealth
• Changes in Inflation Expectations
• Currency Exchange Rate Changes
10. Why AD Curve Slopes Downwards
Falling real
Incomes
• As the price level rises, the real value of income falls and
consumers are less able to buy what they want or need, this is
known as the real balance effect
Balance of
Trade
• A persistent rise in the price level of Country X could make
foreign-produced goods and Services cheaper, causing a fall in
exports and rise in imports
Interest
rate effect
• If the price level rises, this causes inflation and increase in demand
for money and a possible rise in interest rate on loans which then
has a deflationary effect on consumer and business demand
13. Causes of Shifts in Aggregate Demand
Fall in AD
Fall in Exports
Cut in Government
Spending
Higher Interest Rates
Decline in household wealth
Increase in AD
Depreciation of the
Exchange rate
Cuts in Direct and Indirect
Taxes
Increase in Household
wealth
Expansion of supply of
Credit + Lower Intrest Rates
14. Consumption
• Consumption is defined as spending on acquisition of Goods
and Services.
• Types of Consumption
– Private Consumption
• Private consumption is defined as the value of the
Consumption Goods and Services acquired and consumed
by households.
– Government Consumption
• Government Consumption government expenditure on
goods and services that are used for the direct satisfaction
of individual needs or collective needs of members of the
community.
15. Aggregate Demand and Government
of India
• Weakening aggregate demand emerged as a major constraint to
growth in 2008-09, due to decrease in private consumption.
• During this time the Government and RBI realized that, In
long run the policies should be framed in such a way that it
increased consumption, which in turn increase in Aggregate
demand.
• The Covid-19, the Government revenues have fallen lead to
less fiscal space to spend leads to less spending and fail to
support demand.
• If the problem of inadequate demand is not addressed, leads to
prolonged downturn in overall economy.
• RBI said that Government Consumption is the fuel for
Economy during this Pandamic.
Understanding Aggregate Demand
Aggregate demand represents the total demand for goods and services at any given price level in a given period. Aggregate demand over the long-term equals gross domestic product (GDP) because the two metrics are calculated in the same way. GDP represents the total amount of goods and services produced in an economy while aggregate demand is the demand or desire for those goods. As a result of the same calculation methods, the aggregate demand and GDP increase or decrease together.
Technically speaking, aggregate demand only equals GDP in the long run after adjusting for the price level. This is because short-run aggregate demand measures total output for a single nominal price level whereby nominal is not adjusted for inflation. Other variations in calculations can occur depending on the methodologies used and the various components.
Aggregate demand consists of all consumer goods, capital goods (factories and equipment), exports, imports, and government spending programs. The variables are all considered equal as long as they trade at the same market value.
While aggregate demand is helpful in determining the overall strength of consumers and businesses in an economy, it does pose some limitations. Since aggregate demand is measured by market values, it only represents total output at a given price level and does not necessarily represent quality or standard of living.
Also, aggregate demand measures many different economic transactions between millions of individuals and for different purposes. As a result, it can become challenging when trying to determine the causality of demand and run a regression analysis, which is used to determine how many variables or factors influence demand and to what extent.
The following are some of the key economic factors that can affect the aggregate demand in an economy.
1. Changes in Interest Rates: Whether interest rates are rising or falling will affect decisions made by consumers and businesses. Lower interest rates will lower the borrowing costs for big-ticket items such as appliances, vehicles, and homes. Also, companies will be able to borrow at lower rates, which tends to lead to capital spending increases. Conversely, higher interest rates increase the cost of borrowing for consumers and companies. As a result, spending tends to decline or grow at a slower pace, depending on the extent of the increase in rates.
2. Income and Wealth: As household wealth increases, aggregate demand usually increases as well. Conversely, a decline in wealth usually leads to lower aggregate demand. Increases in personal savings will also lead to less demand for goods, which tends to occur during recessions. When consumers are feeling good about the economy, they tend to spend more leading to a decline in savings.
3. Changes in Inflation Expectations: Consumers who feel that inflation will increase or prices will rise, tend to make purchases now, which leads to rising aggregate demand. But if consumers believe prices will fall in the future, aggregate demand tends to fall as well.
4. Currency Exchange Rate Changes: If the value of the U.S. dollar falls (or rises), foreign goods will become more (or less expensive). Meanwhile, goods manufactured in the U.S. will become cheaper (or more expensive) for foreign markets. Aggregate demand will, therefore, increase (or decrease).
